Question

The table below shows the balance sheet (in millions of dollars) for three banks. a. Suppose the required reserve ratio is 5 percent. Fill in the table. Bank of East Los Angeles Bank of Alhambra Bank of Pasadena Assets Liabilities Assets Liabilities Assets Liabilities Deposit: RR: 6 $120 RR:5.7 Deposit:114 RR:5.415 Deposit:108.3 ER:114 ER:108.3 ER:102.885 2400 b. How much money will be created? c. Now suppose the currency drain ratio is 10%. What is the multiplier? d. How much money would be created? e. Now suppose the excess reserve ratio is 10%. How much money would be created?

Answer 1

Answer to the question no. b:

The required reserve ratio is 5%. So, the money multiplier (K) will be:

1 K RRR

$K=\frac{1}{0.05}=20$

Since the size of the money multiplier is 20, A initial deposit of 120 will be able to create 120x20=2400 amount of money.

Answer to the question no. c and d:

The currency drain ratio is the ratio of cash that a person keep as cash in hand and deposits the rest. So, that cash in hand will not be able to create money. Thus, the formula to find the size of the money multiplier is:

1+ CDR K CDR + DRR

The CDR is currency drain ratio (10%=0.01) and the DRR is the desired reserve ratio (DRR) which is equal to 0.05.

Thus,

$K=\frac{1+0.1}{0.1+0.05}=\frac{1.01}{0.15}=6.73$

So, when the currency drain ratio is positive the size of the money multiplier is low.

So, on the initial deposit of 120, 120x6.73=807.6 amount of money will be created.

Answer to the question no. e:

If the excess reserve is 10%, the currency drain ratio is 10% and the required reserve ratio is 5% then the multiplier is:

$K=\frac{1+CDR}{CDR+DRR}=\frac{1+CDR}{CDR+(RRR+ERR)}$

$K=\frac{1+0.1}{0.1+(0.05+0.1)}=\frac{1.01}{0.25}=4.04$

Then with the 120 of initial deposite, a total of 120x4.04=484.4 amount of money will be created.

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