Question

7. The money creation process

Suppose First Main Street Bank, Second Republic Bank, and Third Fidelity Bank all have zero excess reserves. The required reserve ratio is 10%. Hubert, a client of First Main Street Bank, deposits $250,000 into his checking account at First Main Street Bank.

Complete the following table to reflect any changes in First Main Street Bank's T-account (before the bank makes any new loans).

Assets		Liabilities

Complete the following table to show the effect of a new deposit on excess and required reserves when the required reserve ratio is 10%.

Hint: If the change is negative, be sure to enter the value as negative number.

Amount Deposited	Change in Excess Reserves	Change in Required Reserves
(Dollars)	(Dollars)	(Dollars)
250,000

Now, suppose First Main Street Bank loans out all of its new excess reserves to Eileen, who immediately uses the funds to write a check to Clancy. Clancy deposits the funds immediately into his checking account at Second Republic Bank. Then Second Republic Bank lends out all of its new excess reserves to Manuel, who writes a check to Kate, who deposits the money into her account at Third Fidelity Bank. Third Fidelity lends out all of its new excess reserves to Poornima in turn.

Fill in the following table to show the effect of this ongoing chain of events at each bank. Enter each answer to the nearest dollar.

	Increase in Deposits	Increase in Required Reserves	Increase in Loans
	(Dollars)	(Dollars)	(Dollars)
First Main Street Bank
Second Republic Bank
Third Fidelity Bank

Assume this process continues, with each successive loan deposited into a checking account and no banks keeping any excess reserves. Under these assumptions, the $250,000 injection into the money supply results in an overall increase of   in demand deposits.

Answer 1

Assets		Liabilities
Reserves	250000	Liabilities	250000

Amount Deposited	Change in Excess Reserves	Change in Required Reserves
(Dollars)	(Dollars)	(Dollars)
250,000	225000	25000

	Increase in Deposits	Increase in Required Reserves	Increase in Loans
	(Dollars)	(Dollars)	(Dollars)
First Main Street Bank	250000	25000	225000
Second Republic Bank	225000	22500	202500
Third Fidelity Bank	202500	20250	182250

Assume this process continues, with each successive loan deposited into a checking account and no banks keeping any excess reserves. Under these assumptions, the $250,000 injection into the money supply results in an overall increase of 1/0.10*250000 = 10*250000 = 2500000 in demand deposits.