Assume that the following balance sheet portrays the state

.

Assume that the following balance sheet portrays the state of the banking system. The banks currently have no excess reserves.

Assets

Liabilities and Net Worth

(Billions of Dollars)

What is the required reserve ratio?

25%

40%

10%

5%

Suppose that the Federal Reserve (the “Fed”) buys $4 million of bonds from a bond dealer, who immediately deposits the funds in her checking account. What is the initial impact of this transaction?

A) The banking system\'s holdings of securities fall by $4 million, and the banking system\'s total reserves rise by $4 million.

B) Checkable deposits rise by $4 million, and the banking system\'s holdings of securities rise by $4 million.

C) Checkable deposits rise by $4 million, and the banking system\'s total reserves rise by $4 million.

D) The banking system\'s holdings of securities rise by $4 million, and the banking system\'s total reserves fall by $4 million.

As a result of the Fed\'s purchase of $4 million of securities, checkable deposits in the banking system can potentially ___________________? by as much as ____________________?   .

^INCREASE OR DECREASE

Solution

The required reserve ratio will be equal to 10% as the banks currently have no excess reserves it means x% of 50 = 5

Where x is the required reserve ratio

we know that reserve is equal to reserve ratio * deposit

x% * 50 = 5 solving this we get,

x/100 = 5/50

x = 10

So 10% is the required reserve ratio

Option C) is correct.

Other option are a), b) and d) are incorrect because required reserve ratio is 10%.

If the Fed buys $4 million of bonds from a bond dealer, who immediately deposits the funds in her checking account, then the initial impact of this transaction is

B) Checkable deposits rise by $4 million, and the banking system\'s holdings of securities rise by $4 million.

As the fed buys bonds the securities will rises by $4 million and as she immediately deposits the funds in her checking account so it will increase the Checkable deposits.

So, Option B) is correct

Option A) is incorrect because holding of securities will rises by $4 million.

Option C) is incorrect because total reserves will only rise by 10% of $4million i.e., $400000.

Option D) is also incorrect because total reserves will not fall but rises by $400000.

As a result of Fed\'s purchase of $4 million of securities, checkable deposits in the banking system can potentially

Increases . by as much as 40million   because reserve ratio is 10% it means the multiplier is 1/10% = 10

So potentially the Checkable deposit can increase by $4 million * multiplier = 4*10 = $40 million.