Question

A commercial bank has checkable deposit liabilities of $400,000, reserves of $150,000, and a required reserve ratio of 25%. The amount by which a single commercial bank and the amount by which the banking system can increase loans are, respectively:

A. $50,000 and $100,000
B. $50,000 and $150,000
C. $50,000 and $200,000
D. $150,000 and $200,000
(Hint. First estimate how much excess reserves the commercial bank is holding and then estimate what would be the total effect in the economy -apply the money multiplier if those excess reserves are given as a credit to the public)

Answer 1

The single commercial bank can increase loans by its excess reserves of $50,000. The banking system can potentially increase loans by $200,000, which is calculated using the money multiplier based on the 25% reserve ratio.

Step-by-step explanation:

To determine the amount by which a single commercial bank and the banking system can increase loans, we first need to calculate the amount of excess reserves the bank is holding. With a required reserve ratio of 25%, the commercial bank must hold $100,000 in reserves (25% of $400,000 in checkable deposit liabilities). Given that the bank has $150,000 in reserves, the excess reserves amount to $150,000 - $100,000 = $50,000.

This $50,000 represents the additional amount the single commercial bank can lend out. To calculate the total potential loan creation for the banking system, we use the money multiplier formula, which is the inverse of the reserve ratio: 1 / 0.25 = 4. Hence, the banking system can potentially increase the loan amounts by 4 times the single bank's excess reserves, so $50,000 x 4 = $200,000.

The correct answer is: B. $50,000 and $200,000 – This is the amount by which a single commercial bank and the banking system, respectively, can increase loans.