Humongous Bank is the only bank in the economy. The people in this economy have \(\$ 20\) million in money, and they deposit all their money in Humongous Bank. a. Humongous Bank decides on a policy of holding 100\% reserves. Draw a T-account for the bank. b. Humongous Bank is required to hold \(5 \%\) of its existing \(\$ 20\) million as reserves, and to loan out the rest. Draw a T-account for the bank after it has made its first round of loans. c. Assume that Humongous bank is part of a multibank system. How much will money supply increase with that original \(\$ 19\) million loan?

A T-account is a simplified accounting tool used to understand the financial position of a bank. It consists of two columns: one for assets and one for liabilities, resembling the letter 'T'. In a banking context, assets typically include reserves and loans, while liabilities comprise deposits and other debts.

When Humongous Bank accepts deposits of \(\$ 20\) million and holds 100% reserves, the T-account would show \(\$ 20\) million under both assets (as reserves) and liabilities (as deposits). This directly illustrates the bank's decision not to use the deposits to make loans, keeping all funds as liquid reserves instead, which is an unusual practice in modern banking as it foregoes profit from loan interest.

Reserve requirements refer to the rules set by central banks that determine the minimum amount of reserves a bank must hold against deposits. These requirements are crucial for maintaining liquidity and stability in the banking system.

In our exercise, when Humongous Bank is instructed to hold a reserve ratio of 5%, it means the bank must keep 5% of all deposits as reserves and can lend out the remaining 95%. By holding \(\$ 1\) million as reserves from a \(\$ 20\) million deposit, the bank ensures it meets this requirement. The reserve ratio controls the potential for creating new money through lending, as seen with Humongous Bank, which can then loan out \(\$ 19\) million to borrowers.

The money multiplier is a concept that demonstrates how much the money supply can increase based on the reserve requirements. It is calculated as the inverse of the reserve ratio, indicating the maximum potential expansion of the money supply through the banking system’s lending process.

The formula for the money multiplier is simply 1 divided by the reserve requirement ratio. In the example of Humongous Bank, with a 5% reserve requirement, the money multiplier is 20 (1 divided by 0.05). This means that for every dollar of reserves, up to \(\$ 20\) can be created in the banking system through the process of deposit creation and re-lending by multiple banks.

The money supply in macroeconomics refers to the total amount of money available in an economy at a particular time, including currency in circulation and various types of bank deposits. It is influenced by the actions of the central bank and the banking system.

In a multibank system, when the original loan of \(\$ 19\) million from Humongous Bank is circulated through the economy, it undergoes multiple rounds of deposits and loans, leading to an increase in the overall money supply. The potential increase can be calculated using the money multiplier, wherein Humongous Bank's initial \(\$ 19\) million loan can theoretically lead to an increase in the money supply by \(\$ 380\) million. However, it's important to note this is the theoretical maximum, and actual money supply expansion can be less due to factors such as people holding onto cash or banks keeping excess reserves.