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%. The Federal Reserve buys a government bond worth $500,000 from Brian, a client of First Main Street Bank. He deposits the money 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). 

Complete the foilowing 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 

Now, suppose First Main Street Bank loans out all of its new excess reserves to Alyssa, who immediately uses the funds to write a check to Tim. Tim 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 Edison, who writes a check to Crystal, who deposits the money into her account at Third Fidelity Bank. Third Fidelity lends out all of its new excess reserves to Hilary 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. 

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

Answer 1