Question

What is the answer?

10. A man deposited 500,000 to City-Bank. The reserve requirement is 20% of total deposits, and the bank does not hold any excess reserves. a. Create a balance sheet of City-Bank with the given information. b. What is the money multiplier and what is the total money that the entire banking system creates. c. use answer in b, and assuming no capital drain, what should be the new legal reserve requirement if the Central bank aims to increase money supply by 20%.

Answer 1

A. The reserve requirement is 20%, which means the bank will keep .2*500000=100000 in reserves. Since the bank keeps no extra reserves, it means it loans out the rest of 400000. Using a T table, the changes in bank's balance sheet are shown below

Assets Liabilities Reserves 100000 Loans 400000 Deposits 500000

B. Money multiplier is given by

money multiplier=1/reserve ratio. So, in our case

money multiplier=1/.2=5.

The total money created would be 5 times the reserve requirement. So, increase in money supply

=5*500000=2500000.

C. The central bank aims to increase the money supply by 20%, which means the new money supply should be

2500000*1.2=3000000

We know that increase in money supply=money multiplier*deposit. So,

3000000=M*500000

money multiplier=M=6.

And we also know that

M=1/reserve requirement

So,

6=1/reserve requirement

reserve requirement=1/6=16.67%