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Chapter 29: Problem 16

Show the changes to the T-accounts for the Federal Reserve and for commercial banks when the Federal Reserve buys \(\$ 50\) million in U.S. Treasury bills. If the public holds a fixed amount of currency (so that all loans create an equal amount of deposits in the banking system), the minimum reserve ratio is $10 \%$, and banks hold no excess reserves, by how much will deposits in the commercial banks change? By how much will the money supply change? Show the final changes to the T-account for commercial banks when the money supply changes by this amount.

Short Answer

Expert verified
Answer: The change in deposits in commercial banks is $45 million, and the change in the money supply is also $45 million.

Step by step solution

01

Understand the transaction

When the Federal Reserve buys \(50\) million in U.S. Treasury bills, it will "pay" by increasing the reserve accounts of the commercial banks by \(50\) million. The commercial banks, in turn, will give up their \(50\) million in U.S. Treasury bills to the Federal Reserve.
02

Calculate the total change in deposits

Since the banks are holding no excess reserves, and the minimum reserve ratio is \(10 \%\), the banking system must hold \(50\) million × \(0.10 = \$ 5\) million in reserves. The remaining \(50\) million - \(5\) million = \(45\) million can be loaned out. As we are given that the public holds a fixed amount of currency, the banks will loan out the entire \(45\) million, which will create an equal amount of deposits in the banking system. So, the total change in deposits in commercial banks is \(45\) million.
03

Calculate the change in the money supply

The money supply consists of both currency and deposits. In this case, as mentioned earlier, the public holds a fixed amount of currency. So, the change in the money supply will be equal to the change in deposits in the commercial banks, which is \(45\) million.
04

Show the final changes to the T-account for commercial banks

Initially, the T-account for commercial banks looks like this: Assets: Reserves: \(0\) U.S. Treasury bills: \(50\) million Liabilities: Deposits: \(0\) After the transaction: Assets: Reserves: \(50\) million U.S. Treasury bills: \(0\) Liabilities: Deposits: \(45\) million (total change in deposits) Loans: \(45\) million The final T-account for the commercial banks, after the money supply changes by \(45\) million, will be: Assets: Reserves: \(5\) million (required reserves) Loans: \(45\) million Liabilities: Deposits: \(45\) million

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Most popular questions from this chapter

Tracy Williams deposits \(\$ 500\) that was in her sock drawer into a checking account at the local bank. a. How does the deposit initially change the T-account of the local bank? How does it change the money supply? b. If the bank maintains a reserve ratio of \(10 \%\), how will it respond to the new deposit? c. If every time the bank makes a loan, the loan results in a new checkable bank deposit in a different bank equal to the amount of the loan, by how much could the total money supply in the economy expand in response to Tracy's initial cash deposit of \(\$ 500 ?\) d. If every time the bank makes a loan, the loan results in a new checkable bank deposit in a different bank equal to the amount of the loan and the bank maintains a reserve ratio of \(5 \%,\) by how much could the money supply expand in response to Tracy's initial cash deposit of \(\$ 500 ?\)

There are three types of money: commodity money, commodity-backed money, and fiat money. Which type of money is used in each of the following situations? a. Bottles of rum were used to pay for goods in colonial Australia. b. Salt was used in many European countries as a medium of exchange. c. For a brief time, Germany used paper money (the "Rye Mark") that could be redeemed for a certain amount of rye, a type of grain. d. The town of Ithaca, New York, prints its own currency, the Ithaca HOURS, which can be used to purchase local goods and services.

Show the changes to the T-accounts for the Federal Reserve and for commercial banks when the Federal Reserve sells \(\$ 30\) million in U.S. Treasury bills. If the public holds a fixed amount of currency (so that all new loans create an equal amount of checkable bank deposits in the banking system) and the minimum reserve ratio is \(5 \%\), by how much will checkable bank deposits in the commercial banks change? By how much will the money supply change? Show the final changes to the T-account for the commercial banks when the money supply changes by this amount.

What will happen to the money supply under the following circumstances in a checkable-deposits-only system? a. The required reserve ratio is \(25 \%,\) and a depositor withdraws \(\$ 700\) from his checkable bank deposit. b. The required reserve ratio is \(5 \%,\) and a depositor withdraws \(\$ 700\) from his checkable bank deposit. c. The required reserve ratio is \(20 \%,\) and a customer deposits \(\$ 750\) to her checkable bank deposit. d. The required reserve ratio is \(10 \%,\) and a customer deposits \(\$ 600\) to her checkable bank deposit.

The government of Eastlandia uses measures of monetary aggregates similar to those used by the United States, and the central bank of Eastlandia imposes a required reserve ratio of \(10 \% .\) Given the following information, answer the questions below. Bank deposits at the central bank \(=\$ 200\) million Currency held by public \(=\$ 150\) million Currency in bank vaults \(=\$ 100\) million Checkable bank deposits \(=\$ 500\) million Traveler's checks \(=\$ 10\) million a. What is \(\mathrm{M} 1 ?\) b. What is the monetary base? c. Are the commercial banks holding excess reserves? d. Can the commercial banks increase checkable bank deposits? If yes, by how much can checkable bank deposits increase?
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