Reserve Requirement/Deposit Expansion AND BANK

BALANCE SHEET PRACTICE Questions - Show your work

and answer in the space provided
1. What are required reserves? Excess Reserves? How do you calculate total or
actual reserves?

Required Reserves = Checkable deposits banks may not lend out.

Excess Reserves = Checkable deposits banks may lend out.
Actual Reserves = Required Reserves + Excess Reserves.

2. What is the Deposit Expansion Multiplier formula? (or Money Multiplier).

1/reserve requirement.

3. How is money created? Destroyed?

Money is created when banks make loans.

Money is destroyed when loans are paid back

4. Suppose Abe’s Bank has excess reserves of $10,000 and outstanding checkable
deposits of $200,000. If the reserve requirement is 10%, what is the size of the
bank’s actual reserves.

Required Reserves = .10 x $200,000 = $20,000

Actual Reserves = RR + ER = $20,000 + 10,000 = $30,000

5. A reserve requirement of 25% means a bank must have $10,000 of reserves if its
checkable deposits are:
Reserve Requirement = Required Reserves/Checkable Deposits
25% = $10,000/CD = $40,000
6. Suppose the reserve requirement is 25%. If a bank has checkable deposits of $5
million and actual reserves of $2 million, it can safely lend out:
Required Reserves = .25 x $5 Million = $1.25 Million
Excess Reserves = Actual Reserves – Required Reserves = $2 Million - $1.25
Million = $.75 Million or $750,000.
7. Assume Bubba Gump Shrimp Company deposits $1,000 in cash in commercial
Bank Double Zero. If no excess reserves exist at the time this deposit is made and
the reserve ratio is 20%, Bank Double Zero can increase the money supply by a
maximum of:
Required Reserves = .20 x $1,000 = $200
Excess Reserves = Actual Reserves – Required Reserves
= $1,000 - $200 = $800
Use the following to answer questions 8 through 10. Answer the following questions on
the basis of the consolidated balance sheet for the commercial banking system. Assume
the reserve requirement is 20%. All figures are in billions.

Assets Liabilities & Net Worth

Reserves $ 190 Checkable Deposits $ 820

Securities 240 Capital Stock 666
Loans 450
Property 606 _____
Total: $1,486 Total: $1,486

8. The commercial banking system has excess reserves of:

Required Reserves = .20 x $820 = $164

Actual Reserves – Excess Reserves = $190 - $164 = $26 Billion

9. After a deposit of $10 billion of new currency into a checking account in the
banking system, excess reserves will increase by:

Required Reserves = .20 x $10 Billion = $2 Billion

Excess Reserves = AR – RR = $10 Billion - $2 Billion = $8 Billion

10. After the deposit, the maximum amount by which this commercial banking
system can expand the money supply by lending is:

1/.20 = 5; 5 x $34 ($26B + $8B) Billion = $170 Billion

11. A bank has no excess reserves. If it receives $10,000 in cash from a depositor and
the bank finds it can safely lend out $5,000, the reserve requirement must be
_________.

Required Reserves = AR – ER = $10,000 - $5,000 = $5,000

Reserve Requirement = Required Reserves/Checkable Deposits
Reserve Requirement = $5,000/$10,000 = 50%

12. Suppose the reserve requirement is 10%. If a bank has checkable deposits of
$5 million and actual reserves of $1 million, it can safely lend out _________.

Required Reserves = .10 x $5 Million = $.5Million or $500,000

Excess Reserves = AR – RR = $1 Million - .5Million = $ .5 Million

13. If Ellie Mae finds $500 under her mattress and deposits the money in her
checking account at Jed’s bank in Hollywood, what would be the maximum
expansion of the money supply with a reserve requirement of 25%?
 Required Reserves = .25 x $500 = $125
Excess Reserves = AR – RR = $500 - $125 = $375
Max. Expansion = 1/.25 = 4; 4 x $375 = $1,500

14. Suppose the Fed buys $300 Billion in government securities from the public.
With a reserve ratio of 20%, what would be the maximum increase in the money
supply?

Short-Cut Method:

1/.20 = 5; 5 x $300 Billion = $1,500 Billion

Long Method (technically this is how it is done):

Required Reserves = .20 x $300 Billion = $60 Billion

Excess Reserves = $300 Billion - $60 Billion = $240 Billion
Multiplier = 5; Expansion via loans = 5 x $240 Billion = $1,200 Billion
Then: Add back the original deposit because it is all “new” money
From the Fed purchase that counts in money creation

$300 + $1,200 = $1,500 Billion

ANSWER THE QUESTIONS USING THE BANK BALANCE

SHEET PROVIDED:

Davidson’s Bank

Assets Liabilities

Required Reserves $200 Demand Deposits $ 2,000

Excess Reserves 250 Total $ 2,000
Loans 1,450
Bonds 100
Total $2,000

a) What is the reserve requirement ratio?

Required Reserves/Demand Deposits = 200/2000 = 10%

b) How much can this bank loan out?

 $250 in Excess Reserves. One bank can only lend out its excess reserves.

c) How much can the entire banking system expand the money supply by making loans?

You must use the Deposit Expansion or Money Multiplier here.

1/Required Reserves = 1/.10 = 10; 10 x $250 = $2,500

d. If the Fed bought the $100 in bonds from Davidson’s Bank, what would be the
immediate effect on the money supply? How much of this purchase could Davidson’s
bank loan out?

- Increases by $100
- All $100. Because it is the bank’s money and not in a demand deposit, it
is not subject to the reserve requirement. No money has to be set aside as
a required reserve.

e. How much could the money supply ultimately increase through the entire banking
system from this $100 bond purchase?

- Again, we used the multiplier. It is 10; 10 x $100 = $1,000

f. Suppose that Tom Herman, one of Davidson’s customers, withdraws $50 from his
checking account. What effect would this withdrawal have on the following:

1) The money supply:

No change. It is already counted in the Money Supply. The composition

of M, however, changes from demand deposit to cash.

Davidson’s Bank

Assets Liabilities

Required Reserves $200 $195 Demand Deposits $ 2,000 = $1,950

Excess Reserves 250 205 Total $ 2,000 = $1,950
Loans 1,450
Bonds 100
Total $2,000
 $1,950

2) Required Reserves:

a) Recalculate total demand deposits = $2,000 – 50 = $1,950

b) Multiply $1,950 x .10 (reserve requirement) = $195

3) Excess Reserves:

a) Recalculate Actual or Total Reserves:

$450 (200 RR + 250ER) - $50 withdrawal = $400

b) Calculate ER = Actual Reserves minus Required Reserves.

= $400 - $195 = $205

g. Assume the Fed buys $100 in bonds from the public and the money is redeposited
into the banking system:

1. How much of the $100 purchase are required reserves?

.10 x $100 = $10

2. How much are excess reserves?

Excess Reserves = Actual Reserves minus Required Reserves

. = $100 minus $10 = $90

3. What is the maximum expansion of the money supply from this $100 bond
purchase? (assumes the entire banking system is involved)

a) Use the multiplier times excess reserves.

10 x $90 = $900

b) Add back the $100 bond purchase because it is all“new” money

and counts in money creation since it came from The Fed.

$900 + 100 = $1,000 (same final answer as question e above, except the
process is different because the money went into demand deposits. As
such, money had to be reserved.

g) If a bank finds that it does not have enough required reserves to meet Fed requirements,
what can it do to acquire the necessary cash reserves?

a) It may borrow money from the Fed via the Discount Rate.
b) It may borrow money from other banks via the Federal Funds Rate.
 c) It may sell government securities.

i. Assume that Charlie Strong pays back $100 of his loan to Davidson’s Bank. He pays with
a check from his demand deposit at the bank: (start again with the balance sheet as it
originally appeared, not with the changes made by the Tom Herman transaction)

1. What changes occur to the bank’s balance sheet?

Davidson’s Bank

Assets Liabilities

Required Reserves $200 $195 Demand Deposits $ 2,000 = $1,900

Excess Reserves 250 205 Total $ 2,000 = $1,900
Loans 1,450 $1,350
Bonds 100
Total $2,000 $1,900

Liability Side: Demand Deposits will drop by $100. Total Liabilities, therefore,
will drop by $100 to $1,900.
Asset Side: Required Reserves will change because of the deposit as shown below:

Assets and Liabilities both drop from $2,000 to $1,900 from the loan repayment.
Required Reserves = .10 x $1,900 = $190 ($10 drop from $200)
Loans: Decrease from $1,450 to $1,350
Excess Reserves increase from $250 to $260

2. What happens to the money supply due to this $100 loan

repayment?

The money supply decreases by $100. When loans are repaid, the money
supply decreases.

3. How much of this $100 loan repayment may Davidson’s Bank lend out?

All of it. It is all the bank’s money and not a demand deposit which
would be subject to the reserve requirement.

4. How much is the maximum possible expansion of the money supply

from this $100 loan repayment? (this implies the entire banking system)

Take the multiplier x all $100 = 1/.10 = 10; 10 x $100 = $1,000.