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Chapter 15: Q6. (page 318)
“When a commercial bank makes loans, it creates money; when loans are repaid, money is destroyed.” Explain.
The loans increase the checkable deposits and create money, whereas paying off the loans reverses the cycle and destroys the money.
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Why does the Federal Reserve require commercial banks to have reserves? Explain why reserves are an asset to commercial banks but a liability to the Federal Reserve Banks. What are excess reserves? How do you calculate the amount of excess reserves held by the bank? What is the significance of excess reserve?
The actual reason that banks must hold required reserves is:
To enhance liquidity and deter bank runs
To help fund the Federal Deposit Insurance Corporation, which insures bank deposits
To give the Fed control over the lending ability of commercial banks.
To help increase the number of bank loans
Why is the banking system in the United States referred to as a fractional banking reserve system? What is the role of deposit insurance in a fractional reserve system?
Suppose that the banking system in Canada has a required reserve ratio of 10 percent while the banking system in the United States has a required reserve ratio of 20 percent. In which country would $100 of initial excess reserves be able to cause a larger total amount of money creation?
Canada
United States
The following balance sheet is for Big Bucks Bank. The reserve ratio is 20 percent.
| Assets | Liabilities and Net worth | ||||||
| \( | (1) | (2) | \) | (1') | (2') | ||
| Reserves Securities Loans | 22,000 38,000 40,000 | Checkable deposits | 1,00,000 | ||||
a. What is the maximum amount of new loans that Big Bucks Bank can make? Show in columns 1 and 1′ how the bank’s balance sheet will appear after the bank has loaned this additional amount.
b. By how much has the money supply changed?
c. How will the bank’s balance sheet appear after checks drawn for the entire amount of the new loans have been cleared against the bank? Show the new balance sheet in columns 2 and 2′.
d. Answer questions a, b, and c again, on the assumption that the reserve ratio is 15 percent.
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