Question

3. The money supply expansion process

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Suppose First Main Street Bank, Second Republic Bank, and Third Fidelity Bank all have zero excess reserves. The required reserve ratio is 20%. The Federal Reserve buys a government bond worth $750,000 from Clancy, 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 balance sheet (before the bank makes any new loans).

Assets		Liabilities
selector 1Reserves    Building and Furniture Checkable Deposits Loans Net Worth Reserves	selector 2$750,000    $150,000 $600,000 $750,000 $1,800,000	selector 3Checkable Deposits    Building and Furniture Checkable Deposits Loans Net Worth Reserves	selector 4$750,000    $150,000 $600,000 $750,000 $1,800,000

Points:

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Explanation:

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 a negative number.

Amount Deposited	Change in Excess Reserves	Change in Required Reserves
(Dollars)	(Dollars)	(Dollars)
750,000

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Explanation:

Now, suppose First Main Street Bank loans out all of its new excess reserves to Becky, who immediately writes a check for the full amount to Alex. Alex then immediately deposits the funds in his checking account at Second Republic Bank. Then Second Republic Bank lends out all of its new excess reserves to Clancy, who writes a check to Eileen, who deposits the money in her account at Third Fidelity Bank. Finally, Third Fidelity lends out all of its new excess reserves to Kate.

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

Points:

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Explanation:

Assume this process continues, with each successive loan deposited into a checking account and no banks keeping any excess reserves. Under these assumptions, the $750,000 injection into the money supply results in an overall increase of selector 1

• $375,000
• $3,000,000
• $3,750,000

in checkable deposits.

Answer 1

Loan made from reserves
Amount Deposited	Change in Excess Reserves	Change in Required Reserves
(Dollars)	(Dollars)	(Dollars)
750,000	-750,000	150,000	(20% increase)
	Increase in Checkable Deposits	Increase in Required Reserves	Increase in Loans
	(Dollars)	(Dollars)	(Dollars)
First Main Street Bank	0	150,000	750,000
Second Republic Bank	750,000	150,000	600,000	80% loaned, 20% excess reserve
Third Fidelity Bank	600,000	120,000	480,000	80% loaned, 20% excess reserve
the impact of fractional reserve multiplier is seen here.
In this case the multiplier is 0.2
Overall increase= 750,000/0.2
3,750,000