Question

# 7. The money creation process Suppose First Main Street Bank, Second Republic Bank, and Third Fidelity...

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.

 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.

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