Final answer:
When the Fed buys Treasury bonds from Acme Bank, the bank's reserves and capacity to issue loans increase. Conversely, when Acme Bank buys bonds from the Fed, its reserves decrease and it must adjust its loans to maintain required reserve ratios. These transactions significantly alter Acme Bank's balance sheet.
Step-by-step explanation:
Sketching Balance Sheet Changes for Acme Bank Due to Fed's Actions
When open market transactions occur, the Federal Reserve (Fed) either buys or sells Treasury bonds to influence the reserve levels of banks and the overall money supply. In the case of a purchase, the Fed injects liquidity into the bank by increasing its reserves.
In scenario 38, suppose the Fed conducts an open market purchase by buying $10 million in Treasury bonds from Acme Bank. Before the transaction, Acme Bank has $30 million in reserves. After selling the bonds to the Fed, Acme Bank's reserves increase by $10 million. The bank can then use these additional reserves to issue new loans. Assuming all the new reserves are converted into loans, the balance sheet would be adjusted as follows:
Assets: Reserves increase to $40 million (from $30 million), loans increase by $10 million to $60 million (from $50 million).
Liabilities: Deposits remain at $100 million.
Equity stays unchanged at $30 million.
For scenario 39, if the Fed conducts an open market sale and Acme Bank buys $10 million in Treasury bonds from the Fed, the bank's reserves will decrease by $10 million. To maintain the required reserve ratio, Acme has to reduce its loans accordingly. Loans would decrease by $10 million, and the reserves would adjust to meet the necessary requirements. The adjusted balance sheet would show:
- Assets: Reserves decrease to $20 million (from $30 million), loans decrease by $10 million to $240 million (from $250 million).
- Liabilities: Deposits remain at $300 million, but now the reserve ratio is restored to the required 10%.
- Equity remains at $30 million.
In each case, the central theme is how Acme Bank's balance sheet evolves in response to the Fed's monetary policy actions.