Question

1. Suppose that the Fed makes an open market pur- chase of $200,000 in bonds from QRS Bank. a. Show how this affects the Fed balance sheet. b. Show how this affects the balance sheet of QRS Bank. c. Assume that QRS Bank lends out as much as it can, based on this changed situation. What does its balance sheet look like after it makes the loans? d. Assume that all the proceeds from those loans are deposited in TUV Bank. What is the effect on TUV Bank's balance sheet? e. Assume that the required reserve ratio is 10 percent. What new opportunity does TUV Bank now face? What is it likely to do? 2. Cinnase that the Fed makes an open market sale of HII Rank

Answer 1

1) On Fed balance sheet, under assets the securities will increase by $200,000; and under liabilities the reserves will increase by $200,000

2) On QRS Bank balance sheet, under assets the securities will increase by $200,000; and under liabilities the reserves will decrease by $200,000 as it sold the government securities in the form of bonds to the Fed.

3) The QRS bank has excess reserves of $200,000 computed as below:

Excess reserves = [Reserves - Required reserves] = [$200,000 - 0] = $200,000

As QRS bank lends all the excess reserves of $200,000, in it's balance sheet, under assets the loans will increase by $200,000;

4) When loans made out by QRS banks would be deposited in TUV bank, in balance sheet of TUV bank, under assets the loans will increase by $200,000

5) When TUV bank has to keep 10% of the $200,000 as reserve, the required reserves will be $20,000 (=200,000 * 20%); and

Excess reserves = [Reserves - Required reserves] = [$200,000 - 20,000] = $180,000

Now the excess reserves can be loaned out by TUV which amounts $180,000. It can advanced for consumer loans, real estate loans and commercial and industrial loans