Question

Prior to 2008, the Fed did not pay interest on bank reserves. If banks charged 10% on loans and the required reserve ratio was 12%, then for every S1000 in deposits, the amount that banks lost in forgone interest (opportunity cost) because of reserve requirements is $(Round your response to the nearest two decimal place.) Without any interest in reserves, if the interest rate is equal to 5% and the reserve ratio is 15%, then the foregone interest per $500 in deposits, when rounded to the nearest two decimal place, is O A. $75 OB. $25. OC. $3.75 OD. $50

Answer 1

Answer :

1st part :

Required reserve ratio = 12% = 0.12

Interest charged by banks on loans = 10% = 0.10

For every $1000 in deposits, required reserves by the banks = $1000 * 12% = $1000 * 0.12 = $120

Fed did not pay interest on bank reserves

Thus the forgone interest on $120 at 10% = $120 * 10% = $120 * 0.10 = $12

2nd part :

Again no interest on reserves

Required reserve ratio now = 15% = 0.15

Interest charged by banks on loans now = 5% = 0.05

For every $500 in deposits, required reserves by the banks = $500 * 15% = $500 * 0.15 = $75

Forgone interest on $75 at 5% = $75 * 5% = $75 * 0.05 = $3.75

Answer : Option C) $3.75