Question

Initially, the Republic of Gorgonzola has no commercial banking system. To make trading easier and eliminate the need for barter, the government directs the central bank of Gorgonzola to put into circulation 5 million identical paper notes, called guilders. The central bank prints the guilders and distributes them to the people. At this point the Gorgonzolan money supply is 5 million guilders In order to keep the money safe, some Gorgonzolan entrepreneurs set up a system of commercial banks. When people need to make a payment, they can either withdraw their guilders or write a check on their account Checks give the banks permission to transfer guilders from the account of the person paying by check to the account of the person to whom the check is made out. With a system of payments based on checks, the paper guilders need never leave the banking system, although they flow from one bank to another as a depositor of one bank makes a payment to a depositor in another bank. Deposits do not earn interest in this economy. Let's suppose for now that people prefer bank deposits to cash and so deposit all of their guilders with the commercial banks. Assume that initially, the Gorgonzolan commercial banks desire to hold reserves of 20 percent of deposits. Assume that the public holds no currency. Instructions: Enter your responses as integer values. a. The consolidated balance sheet of Gorgonzolan commercial banks after the initial deposits is: Initial balance sheet Assets Liabilities Currency Deposits b. The consolidated balance sheet of Gorgonzolan commercial banks after one round of loans is: Balance sheet after first round of loans Liabilities Assets Currency = reserves) Deposits Loans C. The consolidated balance sheet of Gorgonzolan commercial banks after the first redeposit of guilders is: Balance sheet after redeposits Assets Liabilities Currency = reserves) Deposits Loans

Answer 1

(a) After initial deposits :

Assets	Liabilities
Currency = 5,000,000 guilders	Deposits = 5,000,000 guilders

(b) After one round of loans :

Assets	Liabilities
Currency(=reserves) = 1,000,000 guilders Loans = 4,000,000 guilders	Deposits = 5,000,000 guilders

(c) After 1st re-deposit :

Assets	Liabilities
Currency(=reserves) = 5,000,000 guilders Loans = 4,000,000 guilders [5,000,000 * 0.2]	Deposits = 9,000,000 guilders [5,000,000 + 4,000,000]

(d) After 2 rounds of loans and re-deposits :

Assets	Liabilities
Currency = 5,000,000 guilders Loans = 7,200,000 guilders [4,000,000 + (4,000,000 - 800,000)]	Deposits = 12,200,000 guilders [9,000,000 + (4,000,000 - 800,000)]

(e) Final consolidated bank sheet :

Assets	Liabilities
Currency - Final value of bank reserves = 5,000,000 guilders [25,000,000 * 0.2] Loans = 20,000,000 guilders	Deposits = 25,000,000 guilders

Final value of money supply =  
$\frac{1}{reserve requirement} * initial money supply$ = (1/ 0.2) * 5,000,000 = 25,000,000 guilders

{ Note - Values in bold is the entry to the blank, while explanation has been provided inside square brackets wherever necessary [ ] }