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Homework answers / question archive / Use the following table to answer the following question: Table 1 First National Bank (T-Account) Assets: Liabilities: Reserves: $100,000 Deposits: $500,000 Loans: $400,000 Suppose that in Metropolis there are $500,000 of currency in circulation
Use the following table to answer the following question: Table 1 First National Bank (T-Account) Assets: Liabilities: Reserves: $100,000 Deposits: $500,000 Loans: $400,000 Suppose that in Metropolis there are $500,000 of currency in circulation. There is also a fractional reserve commercial banking system with a 5% reserve requirement. Assume that the T-account for First National Bank, which is the only commercial bank with excess reserves, is given by table 1. If First National Bank decided to reduce its reserves to only the required amount, by how much would the economy's money supply increase?
SOLUTION:-
Required reserve ratio = 5% = 0.05%
Required reserve amount = Deposit * Required reserve ratio
Required reserve amount = 500,000 * 0.05 = $25,000
Now if bank reduce the reserve amount to required reserve amount then the changes in reserves = Reserves - Required reserve amount = 100,000 - 25,000 = $75,000.
Money multiplier = 1 / Required reserve ratio = 1 / 0.005 = 20
Changes in money supply = Changes in reserve * Money multiplier
Changes in money supply = 75,000 * 20 = $1,500,000
Therefore, the economy's money supply will increase by $1,500,000.
