HOMEWORK #8 1. Eli receives $200 in cash for his birthday and deposits the money into his checking account at River Town Bank. a. How does this deposit initially change the T-account of River Town Bank? How does it affect the money supply? b. If the bank maintains a reserve ratio of 15%, how will River Town respond to the new deposit? c. If every time River Town makes a loan, the loan results in a new checkable deposit in a different bank equal to the amount of the loan, by how much could the money supply in the economy expand in total? 2. The Fed has just purchased $100 million in Treasury bills from commercial banks. a. How will this affect the T- accounts for the commercial banks? b. If the public holds a fixed amount of currency (so that all loans create an equal amount of deposits in the banking system), the minimum reserve ratio is 5%, and banks hold no excess reserves, by how much will deposits in the commercial banks change? c. By how much will the money supply change? Describe the final changes to the T- account for commercial banks when the money supply changes by this amount Solution Answer: (a) For River Town bank, this deposit will increase checking deposits (liabilities) by $200 and increase reserves (assets) by $200. Unless this new deposit is lent out as credit, there will be no increase in money supply. (b) Out of $200 deposit, River Town bank will set aside $30 (= $200 x 15%) as required reserves. Balance amount, $170 (= $(200 - 30)) will be excess reserves. The bank may choose to keep $170 as its (excess) reserves, or to lend it out as excess reserves. (c) Total monetary expansion = Initial new deposit / Required reserve ratio = $200 / 0.15 = $1,333.33.