Question

Suppose all banks have zero excess reserves. An individual buys bonds for $2000000 (using money from their satety deposit boxi and a bond dealer deposits the cheque in his or her bank. The desired reserve ratio is 10.5 percent. The bank loans out the maximum it is allowed to a local business. The business writes a cheque for the full amount for supplies, which is then deposited in another (second) bank. The largest loan the second bank can make is $_______ million. Round your final answers to 2 decimal places, if necessary.

Answer 1

The largest loan the second bank can make is $1.79 million.

Step-by-step explanation:

First, we need to calculate the required reserves based on the desired reserve ratio. The individual buys bonds for $2,000,000, so the bank's deposits increase by the same amount. The required reserves are calculated by multiplying the deposits by the reserve ratio:

Required Reserves = Deposits * Reserve Ratio

Required Reserves = $2,000,000 * 0.105

Required Reserves = $210,000

The bank must hold $210,000 in reserves and can loan out the rest. In this case, the rest is $2,000,000 - $210,000 = $1,790,000.

Therefore, the largest loan the second bank can make is $1.79 million.