Question

Assets		Liabilities
Loans		Deposits	$65 million
Required Reserves
Excess Reserves	$2 million
Treasury Securities	$5 million

1. The Fed sets a reserve requirement of 3% on deposits between $16 million and $122 million. If the bank holds $5 million dollars in US Treasury Securities and $2 million in excess reserves, compute the bank’s required reserve level and the quantity of loans this bank is able to make to the public.
2. What is the value of the money multiplier? [Money Multiplier = 1/Effective Reserve Ratio; Effective Reserve Ratio = (Required Reserves + Excess Reserves)/Deposits]
3. Suppose that the Fed increases the required reserve ratio to 5% on deposits between $16 million and $122 million. Further, the bank expands its holdings of US Treasury Securities to $6.5 million and holds $3 million in excess reserves. Calculate the bank’s new required reserve level and the quantity of new loans which this bank is able to make to the public, assuming no change in the quantity of deposits.
4. What is the new value of the money multiplier? Is the change in the reserve requirement an example of expansionary or contractionary monetary policy?

Answer 1

(a)

Deposits = $65 million

Reserve requirement = 3% or 0.03

Required reserves = Deposits * Reserve requirement

Required reserves = $65 million * 0.03 = $1.95 million

Thus,

The bank's required reserve level is $1.95 million.

Loans = Deposits - Required reserves - Excess reserves - Treasury securities

Loans = $65 million - $1.95 million - $2 million - $5 million

Loans = $56.05 million

So,

The quantity of loans this bank is able to make to the public is $56.05 million.

(b)

Calculate the effective reserve ratio -

Effective reserve ratio = [Required reserves + Excess reserves]/Deposits

ERR = [$1.95 million + $2 million]/$65 million

ERR = $3.95 million/$65 million

ERR = 0.06 or 6%

The effective reserve ratio is 6%.

Calculate the money multiplier -

Money multiplier = 1/Effective reserve ratio

Money multiplier = 1/0.06 = 16.67

The value of money multiplier is 16.67

(c)

Now, the Fed increases the required reserve ratio to 5%.

Deposits = $65 million

Reserve requirement = 5% or 0.05

Required reserves = Deposits * Reserve requirement

Required reserves = $65 million * 0.05 = $3.25 million

Thus,

The bank's new required reserve level is $3.25 million.

Loans = Deposits - Required reserves - Excess reserves - Treasury securities

Loans = $65 million - $3.25 million - $3 million - $6.5 million

Loans = $52.25 million

So,

The quantity of new loans this bank is able to make to the public is $52.25 million.

(d)

Calculate the effective reserve ratio -

Effective reserve ratio = [Required reserves + Excess reserves]/Deposits

ERR = [$3.25 million + $3 million]/$65 million

ERR = $6.25 million/$65 million

ERR = 0.096 or 9.6%

The effective reserve ratio is 9.6%.

Calculate the money multiplier -

Money multiplier = 1/Effective reserve ratio

Money multiplier = 1/0.096 = 10.42

The new value of money multiplier is 10.42

The reserve requirement has been increased. This is done when central bank administer contractionary monetary policy.

So,

The change in the reserve requirement is an example of contractionary monetary policy.