Question

Suppose the Bank of Canada buys $5 million worth of government securities from CBA, a commercial...

Suppose the Bank of Canada buys $5 million worth of government securities from CBA,
a commercial bank.
a) Using T-account analysis, show what happens to the balance sheets of the BoC and
CBA immediately.
b) If CBA does not want to hold any excess reserves, it will make more loans. Show the
change for its balance sheet reflecting this lending.
c) Using T-account analysis, show what happens to the balance sheet of the CBA when the
borrower withdraws cash from CBA

d) What is the net change for the balance sheet of CBA after the withdrawal? Show the T-
account.

e)Use the following notation: C is currency in circulation
outside banks, R is bank reserves, D is deposits, L is loans, MB is the monetary base, M is
total money supply, r is the required reserve ratio, and c is the currency-to-deposit ratio.
Assume c = 0.05 and r = 0.2. Suppose all commercial banks hold zero excess reserves.
Following the $5 million open market purchase, what will be the change of C, R, D, L, MB
and M after the money supply process is completed? Calculate:

m = ________________________
∆C = _______________________
∆R = _______________________
∆D = _______________________
∆L = _______________________
∆MB = _____________________
∆M =______________________

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Homework Answers

Answer #1

a)

The purchase of $5 million by BoC increases its asset by $5 million, at the same time it has to pay CBA by increasing the reserve of the bank. This increases the liability of the BoC by the amount of reserve.

The transaction decreases securities and increases reserve by $5 million on the asset side.

Table 1

BoC Balance Sheet
Asset Liability
Securities +5 million Reserve +5 million
CBA Balance Sheet
Asset Liability
Reserve +5 million Deposit
Securities -5 million
Loans

b)

After the bank makes the loan the bank increases the deposit of the borrower by $5 million and this also increases loan in the bank's asset side by the same amount.

CBA Balance Sheet
Asset Liability
Reserve +5 million Deposit +5 million
Securities -5 million
Loans +5 million

c)

After the borrower withdraws all the money from its account the deposit and reserve decreased by $5 million.

CBA Balance Sheet
Asset Liability
Reserve Deposit ----------
Securities -5 million
Loans +5 million

d)

The net change in the balance sheet is the same as before.

CBA Balance Sheet
Asset Liability
Reserve Deposit ---------
Securities -5 million
Loans +5 million

e)

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