Answer the question on the basis of the given consolidated b

Answer the question on the basis of the given consolidated balance sheet of the commercial banking system. Assume that the reserve requirement is 10 percent. All figures are in billions. Assets Liabilities & Net Worth Reserves $60 Checkable Deposits $600 Securities 140 Stock Shares Loans Property 400 260 260 Suppose the Fed bought $20 billion of U.S. securities from the banks. This would Multiple Choice reduce bank reserves to $40 billion, increase bank-held securities to $160 billion, and, assuming a full money multiplier effect, increase the money supply (checkable deposits) by $200 billion. increase bank reserves to $80 billion, reduce bank-held securities to $120 billion, and, assuming a full money multiplier effect, increase the money supply (checkable deposits) by $200 billion. reduce bank reserves to $40bilion, increase bank-held securities to $160 billion, and, assuming a full money multiplier effect, decrease the money supply (checkable deposits) by $200 billion. increase bank reserves to $80 billion, reduce bank-held securities to $120 billion, and, assuming a full money multiplier effect, decrease the money supply (checkable deposits) bv $200 billion.

Solution

Question 1

Fed has bought $20 billion of US securities from banks.

Initially, banks have $140 billion worth of US securities with them.

After banks sold US securities worth $20 billion to Fed, they will be left with $120 billion worth of US securities.

As Fed will pay for the securities (in terms of reserves), reserves with banks will increase from $60 billion to $80 billion.

Reserve requirement = 10% or 0.10

Money multiplier = 1/rr = 1/0.10 = 10

Total increase in money supply = Increase in reserves * mm = $20 billion * 10 = $200 billion

Thus,

This would increase bank reserves to $80 billion, reduce bank-held securities to $120 billion, and, assuming a full money multiplier effect, increase the money supply (checkable deposits) by $200 billion.

Hence, the correct answer is the option (2).

Question 2

Checkable deposits = $200,000

Reserve ratio = 10%

Required reserves = $200,000 * 0.10 = $20,000

At present bank has reserves of $20,000. So, it has only required reserves and no excess reserves.

If it sells $5,000 in securities to Federal Reserve Bank and receives $5,000 in reserves in return.

Then,

The level of excess reserves bank will now have is $5,000.