Chapter 25, Problem 2FRQ

a.

To determine

The excess reserve if $100,000 is the bank’s deposit and reserve ratio is 5% and bank holds $10,000.

Explanation of Solution

The excess reserve refers to the reserve held by the bank above the required reserve. It can be calculated as follows:

  $\begin{array}{c}\text{Required reserve}=\text{Bank deposit}\times \text{required reserve ratio}\\ \text{=\$100,000}\times \text{.05}\\ \text{=\$5,000}\end{array}$

  $\begin{array}{c}\text{Excess reserve}=\text{Bank's reserve}-\text{Required reserve}\\ \text{=\$10,000}-\$5,000\\ =\$5,000\end{array}$

Therefore, excess reserve is $5,000.

Economics Concept Introduction

Required reserve ratio: Required reserve ratio refers to the portion of the total money deposits that is collected by the banks. This amount cannot be used for further lending or investing purpose. The percentage is decided by the Federal Reserve.

b.

To determine

The amount should be held as reserve and the amount that can be lent out if additional deposit of $1,000 is made.

Explanation of Solution

Given Information:

Required reserve ratio is 5%

Additional deposit is $1000

There is no excess reserve held with the bank.

Calculations:

The amount that bank can keep as reserve is as follows:

  $\begin{array}{c}\text{Required reserve}=\text{Bank deposit}\times \text{required reserve ratio}\\ \text{=\$1000}\times \text{.05}\\ \text{=\$50}\end{array}$

The amount after deducting reserves from the additional deposit can be lent out by the bank which is $950 ($1000-$50).

Economics Concept Introduction

Required reserve ratio: Required reserve ratio refers to the portion of the total money deposits that is collected by the banks. This amount cannot be used for further lending or investing purpose. The percentage is decided by the Federal Reserve.

c.

To determine

The effect on money supply if reserves are increased by $2,000.

Explanation of Solution

Money multiplier can be determined by using 1/reserve ratio which is computed as follows:

  $\begin{array}{c}\text{Money multiplier}=\frac{1}{0.05}\\ =20\end{array}$

Change in money supply can be determined by multiplying the change in monetary base and the money multiplier. It is as follows:

  $\begin{array}{c}\text{Change in money supply}=\text{Money multiplier}\times \text{Change in monetary base}\\ \text{=20}\times \text{\$20,000}\\ \text{=\$40,000}\end{array}$

Therefore, money supply will be change by $40,000

Economics Concept Introduction

Required reserve ratio: Required reserve ratio refers to the portion of the total money deposits that is collected by the banks. This amount cannot be used for further lending or investing purpose. The percentage is decided by the Federal Reserve.