Question

Initially, the Republic of Gorgonzola has no commercial banking system. Then, the government directs the central bank of Gorgonzola to put into circulation 2,000,000 identical paper notes, called guilders. The central bank prints the guilders and distributes them to the population. In order to safeguard the money, some Gorgonzolan entrepreneurs set up a system of commercial banks. When people need to make a payment, they can either withdraw their guilders or, more conveniently, write a check on their account. Checks give the banks permission to transfer guilders from the account of the person paying by check to the account of the person to whom the check is made out. With a system of payments based on checks, the paper guilders need never leave the banking system, although they flow from one bank to another as a depositor of one bank makes a payment to a depositor in another bank. Deposits do not pay interest in this economy.

Let’s suppose for now that people prefer bank deposits to cash and so deposit all of their guilders with the commercial banks.

Assume that (1) initially, the Gorgonzolan central bank puts 2,000,000 guilders into circulation and (2) commercial banks desire to hold reserves of 25 percent of deposits. Assume that the public holds no currency.

Instructions: Enter your responses as integer values.

a. The consolidated balance sheet of Gorgonzolan commercial banks after the initial deposits is:

Balance sheet after initial deposits

Assets		Liabilities
Currency_____		Deposits______

b. The consolidated balance sheet of Gorgonzolan commercial banks after one round of loans is:

Balance sheet after first round of loans

Assets		Liabilities
Currency (= reserves)		Deposits
Loans

c. The consolidated balance sheet of Gorgonzolan commercial banks after the first redeposit of guilders is:

Balance sheet after redeposits

Assets		Liabilities
Currency (= reserves)		Deposits
Loans

d. The consolidated balance sheet of Gorgonzolan commercial banks after two rounds of loans and redeposits is:

Balance sheet after second round of loans and redeposits

Assets		Liabilities
Currency (= reserves)		Deposits
Loans

e. The final values of bank reserves, loans, deposits, and the money supply are:

Final consolidated balance sheet

Assets		Liabilities
Currency Final value of bank reserves		Deposits
Loans

               

Money supply:   guilders.     

Answer 1

d)

Again public who takes the loan redeposit the loan amount in the bank and the bank balance sheet after 2nd round of redeposit is

Assets	Liabilities
Currency	Deposit
3500000	6125000
Loan
2625000

e)

In this way, the deposit gets multiplied and the bank keeps creating new loan until there is no excess reserve left to loan after last round of redeposit. the final deposit will be multiplier times of initial deposit. The multiplier is the reciprocal of the desired deposit ratio or 1/0.25=4. Then the final deposit will be 4 times of 2,000,000 or 8,000,000.

The final bank balance sheet

Assets	Liabilities
Currency	Deposit
2000000	8000000
Loan
6000000

Therefore, the money supply is 8,000,000.