Question

Table 1 shows the financial position of the Smithville Bank once $4893.00 has been deposited.

Assume that the required reserve ratio is 5.00% .

The bank manager decides to lend Billy Bob Smith all of the bank's excess reserves. Billy Bob takes the funds to Eula Mae's Used Machines and buys a pickup truck. Eula Mae then deposits the money in her account back at the Smithville Bank.

Table 2 should show the bank's accounts after the loan is made and the funds again deposited. Round all answers to the nearest cent.

What are the bank's loans in Table 2?
$_________
What are the bank's reserves in Table 2?
$_________
What are the bank's deposits in Table 2?
$_________

Answer 1

What are the bank's loans in Table 2? - $4648.35

What are the bank's reserves in Table 2? - $4893.00

What are the bank's deposits in Table 2? - $9541.35

The problem assumes that the bank does not keep excess reserves, meaning that the bank will only keep 5.00% of any deposit and loan out the remaining 95.00% . The loan to Billy Bob is therefore:

$4893.00×(100%−5.00%)=$4648.35

The problem also assumes that loaned funds are deposited back into the Smithville Bank. Hence, the $4648.35 that was loaned out to Billy Bob is redeposited back into the bank by Eula Mae. This amount is added to its existing reserves, and can be represented by:

($4893.00×5.00%)+$4648.35=$4893.00

The bank's deposits are now the sum of the initial $4893.00 deposit and the $4648.35 that Eula Mae redeposited, or $9541.35 . This loan increases the money supply.

Note that Eula Mae's deposit puts Smithville Bank over the required reserve ratio again, so it will make additional loans. This ongoing sequence of smaller and smaller loans and redeposits will eventually have a multiplier effect on the money supply.