The money creation process

Dismiss All

Please Wait . . .

Please Wait...

Suppose First Main Street Bank, Second Republic Bank, and Third Fidelity Bank all have zero excess reserves. The required reserve ratio is 10%. The Federal Reserve buys a government bond worth $500,000 from Raphael, a client of First Main Street Bank. He deposits the money into his checking account at First Main Street Bank.

Complete the following table to reflect any changes in First Main Street Bank's T-account (before the bank makes any new loans).

Assets		Liabilities
selector 1Reserves Building and furniture Deposits Loans Net worth Reserves	selector 2 $50,000 $450,000 $500,000 $1,100,000	selector 3 Building and furniture Deposits Loans Net worth Reserves	selector 4 $50,000 $450,000 $500,000 $1,100,000

Points:

Close Explanation

Explanation:

Complete the following table to show the effect of a new deposit on excess and required reserves when the required reserve ratio is 10%.

Hint: If the change is negative, be sure to enter the value as negative number.

Amount Deposited	Change in Excess Reserves	Change in Required Reserves
(Dollars)	(Dollars)	(Dollars)
500,000

Points:

Close Explanation

Explanation:

Now, suppose First Main Street Bank loans out all of its new excess reserves to Megan, who immediately uses the funds to write a check to Larry. Larry deposits the funds immediately into his checking account at Second Republic Bank. Then Second Republic Bank lends out all of its new excess reserves to Alex, who writes a check to Susan, who deposits the money into her account at Third Fidelity Bank. Third Fidelity lends out all of its new excess reserves to Becky in turn.

Fill in the following table to show the effect of this ongoing chain of events at each bank. Enter each answer to the nearest dollar.

	Increase in Deposits	Increase in Required Reserves	Increase in Loans
	(Dollars)	(Dollars)	(Dollars)
First Main Street Bank
Second Republic Bank
Third Fidelity Bank

Points:

Close Explanation

Explanation:

Assume this process continues, with each successive loan deposited into a checking account and no banks keeping any excess reserves. Under these assumptions, the $500,000 injection into the money supply results in an overall increase of selector 1

$500,000

$4,500,000

$5,000,000

in demand deposits.