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Assume that all banks follow the same required reserve ratio requirement. Also assume that the banks are listed in sequential order Answer

1. Assume that all banks follow the same required reserve ratio requirement. Also assume that the banks are listed in sequential order (thus the loans from The First National Bank become the deposits for the Second National Bank, and the loans from the Second National Bank become the deposits for the Third National Bank, and so on). Also, the banks’ balance sheets must always be balanced so total assets must equal total liabilities.

 

Table: National Banks

1st National Bank

ASSETS LIABILITIES
Required reserves $26,000 Deposits $520,000
Loans 494,000
TOTAL 520,000 TOTAL 520,000

 

2nd National Bank

ASSETS LIABILITIES
Required reserves 98,800 Deposits           494,000
Loans 395,200
TOTAL 494,000 TOTAL           494,000

 

3rd National Bank

ASSETS LIABILITIES
Required reserves 79,040 Deposits           395,200
Loans 316,160
TOTAL 395,200 TOTAL           395,200

 

a.       Using the above table of national banks, fill in the spaces for (1) required reserves, (2) deposits, and (3) loans for each bank. Then answer the following questions.

 

b.      What is the initial money multiplier in this country?

 

Required reserve ratio= 26000/520000= 0.2 Or 20%

Multiplier= 1/.2= 5

 

c.       Now suppose that banks are worried about an increased demand for withdrawals, so each bank maintains an extra 3 percent of deposits over and above required reserves. What is the effective money multiplier now?

The money multiplier= 1/.23= 4.3478

d.      What problem with monetary policy is illustrated by this question?

 

This shows that the money supply changes according to the required reserves ratio as well as the banks’ own reserves estimate. The central bank can not dictate how money supply will change as banks can keep more than required funds as reserves. This lowers the amount available for loans. This defeats the central bank policy of changing money supply by changing the reserve requirement. Monetary policy becomes ineffective then.

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