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Chapter 29: Problem 5

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 \(\$ 500 ?\)

Short Answer

Expert verified
Answer: A decrease in the reserve ratio, such as from 10% to 5%, leads to a greater total possible money supply expansion in the banking system. As the reserve ratio decreases, the money multiplier increases, resulting in more potential money being created through the process of lending and redepositing.

Step by step solution

01

Analyze the initial deposit's impact on the T-account and money supply

Tracy deposits $500 into her checking account. This increases the bank's assets (cash) and liabilities (customer deposits). The money supply M1 (which includes cash and checkable deposits) doesn't change, as cash is converted into checkable deposits.
02

Determine the bank's response to the new deposit based on the reserve ratio

The bank has a reserve ratio of \(10\%\), which means it must hold \(10\%\) of its deposits as reserves. With the new deposit of \(500, the bank will keep \)50 (10\% \times 500)\( as reserves and can potentially lend out the remaining \)\$450$.
03

Calculate the total possible money supply expansion using the money multiplier

The money multiplier for a reserve ratio of \(10\%\) is \(\frac{1}{0.10}=10\). Tracy's \(\$500\) deposit can potentially create \(500\times 10 = \$ 5,000\) of additional money in the economy through the process of lending and redepositing in different banks.
04

Calculate the total possible money supply expansion with a reserve ratio of \(5\%\)

The money multiplier for a reserve ratio of \(5\%\) is \(\frac{1}{0.05}=20\). Tracy's \(\$500\) deposit can potentially create \(500\times 20 = \$ 10,000\) of additional money in the economy with a \(5\%\) reserve requirement. This demonstrates how a lower reserve ratio leads to greater potential money supply expansion.

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Most popular questions from this chapter

For each of the following transactions, what is the initial effect (increase or decrease) on M1? On M2? a. You sell a few shares of stock and put the proceeds into your savings account. b. You sell a few shares of stock and put the proceeds into your checking account. c. You transfer money from your savings account to your checking account. d. You discover \(\$ 0.25\) under the floor mat in your car and deposit it in your checking account. e. You discover \(\$ 0.25\) under the floor mat in your car and deposit it in your savings account.

Ryan Cozzens withdraws \(\$ 400\) from his checking account at the local bank and keeps it in his wallet. a. How will the withdrawal change the T-account of the local bank and the money supply? b. If the bank maintains a reserve ratio of \(10 \%\), how will it respond to the withdrawal? Assume that the bank responds to insufficient reserves by reducing the amount of deposits it holds until its level of reserves satisfies its required reserve ratio. The bank reduces its deposits by calling in some of its loans, forcing borrowers to pay back these loans by taking cash from their checking deposits (at the same bank) to make repayment. c. If every time the bank decreases its loans, checkable bank deposits fall by the amount of the loan, by how much will the money supply in the economy contract in response to Ryan's withdrawal of \(\$ 400 ?\) d. If every time the bank decreases its loans, checkable bank deposits fall by the amount of the loan and the bank maintains a reserve ratio of \(20 \%\), by how much will the money supply contract in response to a withdrawal of $\$ 400 ?$

In Westlandia, the public holds \(50 \%\) of \(\mathrm{M} 1\) in the form of currency, and the required reserve ratio is \(20 \%\). Estimate how much the money supply will increase in response to a new cash deposit of \(\$ 500\) by completing the accompanying table. (Hint: The first row shows that the bank must hold \(\$ 100\) in minimum reserves \(-20 \%\) of the \(\$ 500\) deposit- against this deposit, leaving \(\$ 400\) in excess reserves that can be loaned out. However, since the public wants to hold \(50 \%\) of the loan in currency, only \(\$ 400 \times 0.5=\$ 200\) of the loan will be deposited in round 2 from the loan granted in round 1.) How does your answer compare to an economy in which the total amount of the loan is deposited in the banking system and the public doesn't hold any of the loan in currency? What does this imply about the relationship between the public's desire for holding currency and the money multiplier?

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?

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.
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