Question

Suppose First Main Street Bank loans out all of its new excess reserves to Cho, who immediately uses the funds to write a check to Bob. Bob deposits the funds immediately into his checking account at Second Republic Bank. Then Second Republic Bank lends out all of its new excess reserves to Eric, who writes a check to Ginny, who deposits the money into her account at Third Fidelity Bank. Third Fidelity lends out all of its new excess reserves to Lucia as well.

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)
First Main Street Bank
Second Republic Bank
Third Fidelity 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 $1,500,000 injection into the money supply results in an overall increase of_______ in demand deposits.

Answer 1

First Main Street Bank

Increase in deposit at First Main Street Bank = $1.5 million

Increase in Required Reserves = $45,000

Increase in Loans = $1.455 million

Second Republic Bank

Increase in deposit at Second Republic Bank = $1.455 million

Increase in Required Reserves = $43,650

Increase in Loans= $1.411 million

Third Fidelity Bank

Increase in deposit at Third Fidelity Bank = $1.411 million

Increase in Required Reserves = $42,330

Increase in Loans= $1.369 million

$50 million

Step-by-step explanation:

Required reserves is the percentage of deposits required of banks to keep as reserves by the central bank

Required reserves = reserve requirement x deposits

Excess reserves is the difference between reserves and required reserves

The required reserves of the Feds is 3% for deposits less than 14.5 million. Since the required reserve was not mentioned, 3% would be used

Increase in deposit at First Main Street Bank = 1.5 million

Increase in Required Reserves = 3% x 1.5 million = $45,000

Since all of excess reserve is loaned out, 97% of the deposit would be loaned out (100 - 3%)

97% x 1.5 million = 1.455 million

Second Republic Bank

Increase in deposit at Second Republic Bank = $1.455 million

Increase in Required Reserves = 3% x1.455 million = $43,650

Increase in Loans= 0.97 x 1.455 million = $1.411 million

Third Fidelity Bank

Increase in deposit at Third Fidelity Bank = $1.411 million

Increase in Required Reserves = 3% x 1.411 million = $42,330

Increase in Loans= 0.97 x 1.411 million = 1.369 million

Overall increase in money supply would be determined by the money multiplier

Money multiplier = amount deposited / reserve requirement

$1,500,000 / 0.03 = $50 million