ECON

Complete the following table to show the effect of a new deposit on excess and required reserves when the required reserve ratio is 20%. Hint: If the change is negative, be sure to enter the value as negative number.

Amount Deposited: $1,500,000 Change in Excess Reserves: $1,200,000 Change in Required Reserves: $300,000 Explanation: Because the required reserve ratio is 20%, First Main Street Bank is required to hold 20% of its fresh reserves (that is, the initial deposit). Since 20% of $1,500,000 is $300,000, this means that First Main Street Bank's required reserve has increased by $300,000. The remaining 80% of the fresh reserves, or $1,200,000, is excess reserves and can be used to make loans

Assume this process continues, with each successive loan deposited into a checking account and no banks keeping any excess reserves. Under these assumptions, the $1,500,000 injection into the money supply results in an overall increase of _________ in demand deposits.

$7,500,000 Explanation: Under the assumptions stated in the problem, you can use the money multiplier to calculate the eventual effect of the $1,500,000 injection into the money supply. The formula for the money multiplier is 1/r , where r is the required reserve ratio. Therefore, the resulting change in demand deposits is as follows: Change in Demand Deposits = Change in Fresh Reserves (that is, the Initial Deposit)×1/r = $1,500,000×1/0.20 = $7,500,000

Which of the following is true of the capital requirement? Check all that apply. 1. It specifies a minimum leverage ratio for all banks. 2. Its intended goal is to protect the interests of the depositors. 3. Its intended goal is to protect the interests of those who hold equity in the bank.

2. Its intended goal is to protect the interests of the depositors. Explanation: Capital requirements are designed to ensure that banks will have sufficient capital to repay the depositors and debtors. A bank's "capital" is the difference between the total value of the bank's assets and its total deposits plus debt. That is, the bank's capital is the money that would be left over if the bank were able to liquidate all of its assets to pay off all of its depositors and debtors. If a bank holds a high percentage of "risky" assets (such as loans that could be defaulted on), capital requirements are higher to ensure that the bank will remain solvent—even if some of its loans are not repaid. Thus the capital requirement does not specify any set requirement for all banks but rather determines the amount of capital that is appropriate to balance the amount of risk a bank carries with its asset allocation.

The federal funds rate is the interest rate that banks charge one another for short-term (typically overnight) loans. When the Federal Reserve uses open-market operations to buy government bonds, the quantity of reserves in the banking system ______ , banks' need to borrow from each other ______ , and the federal funds rate______ .

increases, declines, decreases Explanation: To reduce the federal funds rate, the Federal Reserve uses open-market operations to buy government bonds from the public. The Federal Reserve's government bonds purchase injects reserves into the banking system. With additional reserves, banks are no longer as close to their required reserve ratio, so the need for banks to borrow from each other declines, pushing the federal funds rate downward. Similarly, the Federal Reserve sells government bonds in order to raise the federal funds rate. The sale of government bonds reduces the quantity of reserves in the banking system, causing banks' need to borrow from each other to rise, pushing the federal funds rate upward.

Which of the following do bankers take into account when determining how to allocate their assets? Check all that apply. 1. The size of the monetary base 2. The return on each asset 3. The total value of liabilities

2. The return on each asset Explanation: When determining how to allocate their assets among reserves, loans, and financial securities, banks must first make sure that their reserves are sufficient to meet the reserve requirement set by their regulators. Bankers can then choose how to allocate the remainder of their assets between holding additional reserves, making loans, and investing in securities. Each one of these asset types comes with a different level of risk and rate of return. Riskier assets tend to yield a higher rate of return; thus, individual banks choose the asset allocation that provides the correct balance of risk and profit. The total size of the monetary base and the total value of liabilities both affect the total value of a bank's assets, but they do not directly influence the manner in which a bank chooses to allocate those assets.

Suppose First Main Street Bank, Second Republic Bank, and Third Fidelity Bank all have zero excess reserves. The required reserve ratio is 20%. Hubert, a client of First Main Street Bank, deposits $1,500,000 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: Reserves $1,500,000 Liabilities: Deposits $1,500,000 Explanation: When Hubert deposits the $1,500,000 into First Main Street Bank, it creates both an asset and a liability for the bank. On the asset side of the T-account, the $1,500,000 increases the bank's reserves. The bank can use some of these additional reserves to make loans to other people. On the liability side of the T-account, the $1,500,000 is recorded as a demand deposit, because Hubert could demand his deposit back at any time by coming into the bank and asking for it, by writing a check, or by using a debit card.

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 First Main Street Bank: 1,500,000 300,000 1,200,000 Second Republic Bank: 1,200,000 240,000 960,000 Third Fidelity Bank: 960,000 192,000 768,000 Explanation: You already found that of the $1,500,000 initial deposit, 20% (or $300,000) had to be held as required reserves and the remaining 80% (or $1,200,000) could be loaned out. If you follow that $1,200,000 loan, you can see that when it is deposited into Second Republic Bank, 20% of that $1,200,000 must be held as required reserves by Second Republic Bank and the remaining 80% can be loaned out: Increase in Second Republic Bank's Required Reserves = 0.20×$1,200,000 = $240,000 Increase in Second Republic Bank's Excess Reserves = 0.80×$1,200,000 = $960,000 Now, those $960,000 of excess reserves can be loaned out. When they are loaned and then deposited into Third Fidelity Bank, Third Fidelity Bank's required and excess reserves increase in the same way: Increase in Third Fidelity Bank's Required Reserves = 0.20×$960,000 = $192,000 Increase in Third Fidelity Bank's Excess Reserves = 0.80×$960,000 = $768,000

The discount rate is the interest rate on loans that the Federal Reserve makes to banks. Banks occasionally borrow from the Federal Reserve when they find themselves short on reserves. A lower discount rate_____ banks' incentives to borrow reserves from the Federal Reserve, there by _______ the quantity of reserves in the banking system and causing the money supply to________ .

Increases, increasing, rise Explanation: Banks can borrow funds from the Federal Reserve to make more loans when their own reserves approach the minimum amount allowed by the required reserve ratio. An increase in the discount rate makes borrowing from the Federal Reserve more expensive for banks. Because banks know that lending past the required reserve ratio will be more costly, they will be stingier with their lending, and fewer loans will be made. Fewer loans made means less money is created. A decrease in the discount rate has the opposite effect. Borrowing from the Federal Reserve becomes less expensive, so banks borrow more reserves from the Federal Reserve, increasing the level of reserves in the banking system. The injection of reserves allows banks to make more loans, creating additional money and increasing the money supply.