Question

You are given this balance sheet for a bank.

Assets Liabilities

Reserves $ 200 Deposits $2,000

Loans $ 1,800

The required reserve ratio is 10%.

a. How much is its excess reserve?

b. Suppose Ms. A deposits $1,000 to her account at this bank. Show the effect of this transaction on the bank’s balance sheet. How much is its excess reserve after the transaction?

c. How much will M1 increase when the money creation process (involving the whole banking sector and the general public) from the loan-making of this bank (using its excess reserve from part (b)) is completed?

Answer 1

a. With required reserve ratio of 10 %, required reserves are 10 % of deposits which is 200. Therefore excess reserves are zero.

b. With 1000 $ of new deposits, the total deposits will rise by 1000 $, the required reserves will be 300$ (10% of deposits) and the excess reserve will be 900. The new balance sheet will be

ASSETS	LIABILITIES
Required reserves	300	Demand deposits	3000
Excess reserves	900
Loans	1800
	3000		3000

c. When the bank will loan out the excess reserves, the maximum change in M1 depends on multiplier effect.

Multiplier = 1 / Reserve ratio = 1 / 0.1 = 10

Maximum change in money supply = 10 * excess reserves = 10 * 900 = 9000 $