Question

Answer the following questions based on the simplified balance sheet below. Assume the reserve ratio = 0.10 or 10%.

                                                Assets                         Liabilities

                        ________________________________________________

                        Required Res. $200                            $2000 demand deposits

                        Excess Res.     $800

                        Bonds              $500

                        IOU's              $500

                        ________________________________________________

                                               $2000                          $2000

By how much will M-1 have changed if this loan is made?

Answer 1

Given balance sheet

ASSETS	LIABILITIES
Required Reserves	200	Demand Deposits	2000
Excess Reserves	800
Bonds	500
IOUs	500
	2000		2000

Reserve Ratio = 10%

Therefore Reserve Requirements will be 10% of Demand deposits = 200$

M1 money is the narrowest definition of the money supply. It consists of liquid cash in the form of currency and coins, traveller’s checks, demand deposits or checkable deposits.

Multiplier = 1/Reserve ratio = 10

When Excess Reserves are lend as loans, the increase in M1 it will create will be multiplier * Excess reserves

800 * 10 = 8000 $

Lending Excess Reserves will increase the demand deposits as well as M1 money supply.