It has been determined that, in aggregate, financial institutions with depository accounts currently hold excess reserves equal to $3 billion—that is, they hold $3 billion more than is necessary to meet the reserve requirements associated with existing deposits. The reserve requirement applicable to all deposits is 15 percent. Assume that changes in reserves held by financial institutions affect deposits only (i.e., amounts lent out are always redeposited in the financial institutions).
a. All else being equal, what would be the effect on deposits if financial institutions immediately eliminated all of their excess reserves?
b. All else being equal, what would be the effect on deposits if financial institutions adjusted their reserves so that excess reserves decreased to $1.2 billion?
c. Describe the effects that either of the preceding actions would have on interest rates in the financial markets.