Question

Suppose Southeast Mutual Bank, Walls Fergo Bank, and PJMorton Bank all have zero excess reserves. The required reserve ratio is presently set at 25%. Andrew, a Southeast Mutual Bank customer, deposits $1,800,000 into his checking account at the local branch. Complete the following table to reflect any changes in Southeast Mutual Bank's T-account (before the bank makes any new loans). Assets Liabilities Complete the following table to show the effect of a new deposit on excess and required reserves when the required reserve ratio is 25%. Hint: If the change is negative, be sure to enter the value as negative number. Amount Deposited Change in Excess Reserves Change in Required Reserves (Dollars) (Dollars) (Dollars) 1,800,000 Now, suppose Southeast Mutual Bank loans out all of its new excess reserves to Teresa, who immediately uses the funds to write a check to Sam. Sam deposits the funds immediately into his checking account at Walls Fergo Bank. Then Walls Fergo Bank lends out all of its new excess reserves to Darnell, who writes a check to Beth, who deposits the money into her account at PJMorton Bank. PJMorton lends out all of its new excess reserves to Eleanor in turn. Fill in the following table to show the effect of this ongoing chain of events at each bank. Enter each answer to the nearest dollar. Increase in Deposits Increase in Required Reserves Increase in Loans (Dollars) (Dollars) (Dollars) Southeast Mutual Bank Walls Fergo Bank PJMorton Bank Assume this process continues, with each successive loan deposited into a checking account and no banks keeping any excess reserves. Under these assumptions, the $1,800,000 injection into the money supply results in an overall increase of in demand deposits.

Answer 1

The $1,800,000 injection into the money supply results in an overall increase of $7,200,000 in demand deposits.

Step-by-step explanation:

When Andrew deposits $1,800,000 into his checking account at Southeast Mutual Bank, the bank's liabilities increase by the same amount, reflecting the new demand deposit. The required reserve ratio is 25%, so Southeast Mutual Bank must hold $450,000 (25% of $1,800,000) as required reserves. The remaining $1,350,000 becomes excess reserves.

Now, as Southeast Mutual Bank loans out its excess reserves of $1,350,000 to Teresa, and this process continues through Walls Fergo Bank, PJMorton Bank, and finally to Eleanor, the total increase in demand deposits is the sum of the initial deposit and the subsequent loans. Each bank makes new loans equivalent to its excess reserves, and as these loans are deposited into other banks, they create additional demand deposits. The cumulative increase is calculated by multiplying the initial deposit by the money multiplier.

The money multiplier is the reciprocal of the reserve requirement ratio. In this case, the reserve requirement ratio is 25%, so the money multiplier is 1/0.25, which equals 4. Therefore, the overall increase in demand deposits is $1,800,000 (initial deposit) multiplied by 4, resulting in $7,200,000.

In summary, the initial deposit sets off a chain reaction of loans and deposits through the banking system, leading to a total increase in demand deposits of $7,200,000. This process is guided by the reserve requirement ratio and the money multiplier, reflecting the impact of the initial deposit on the overall money supply.

Answer 2

Andrew's deposit increases Southeast Mutual Bank's reserves, leading to a series of loans and deposits across multiple banks due to the 25% required reserve ratio. This illustrates the money multiplier effect, ultimately expanding the money supply up to a potential maximum of $7,200,000.

Step-by-step explanation:

The question asks about the effects of a deposit on a bank's reserves and subsequent loans made by banks in the system when the required reserve ratio is set at 25%. After Andrew deposits $1,800,000 into Southeast Mutual Bank, the bank's required reserves increase by $450,000 (25% of $1,800,000), and its excess reserves increase by $1,350,000, which can be loaned out. When Southeast Mutual Bank loans the $1,350,000 in excess reserves to Teresa, and as the funds move through Walls Fergo Bank and PJMorton Bank, this sequence of events leads to an increase in loans and deposits at each bank proportional to their excess reserves, creating new money in the economy known as the money multiplier effect. Using the money multiplier, we can calculate the maximum potential increase in the money supply, which would be $7,200,000 (4 times the initial deposit) as all banks loan out their maximum possible new excess reserves and the loans continue to be redeposited.