Question

7. The money creation process
Suppose First Main Street Bank, Second Republic Bank, and Third Fidelity Bank all have zero excess reserves. The required reserve ratio is 20%. Sam, a client of First Main Street Bank, deposits $1,500,000 into his checking account at First Main Street Bank.
Complete the following table to reflect any changes in First Main Street Bank's T-account (before the bank makes any new loans).
Assets :   

Building and furniture ,Deposits,Loans,net worth,reserves ?

($300,000/ $1,200,000 / $1,500,00 /$3,600,00 ) ?

Liabilities:

Building and furniture ,Deposits,Loans,net worth,reserves?   

($300,000/ $1,200,000 / $1,500,00 /$3,600,00 ) ?   

  

  

Complete the following table to show the effect of a new deposit on excess and required reserves when the required reserve ratio is 20%.
Hint: If the change is negative, be sure to enter the value as negative number.
Amount Deposited /////////////////// Change in Excess Reserves ////////////////////////// Change in Required Reserves
(Dollars)///////////////////////////////////////// (Dollars) //////////////////////////////////////////////////////////////(Dollars)
1,500,000 /////////////////////////////////////////////? /////////////////////////////////////////////////////////////////////////////?

Now, suppose First Main Street Bank loans out all of its new excess reserves to Neha, who immediately uses the funds to write a check to Lorenzo. Lorenzo deposits the funds immediately into his checking account at Second Republic Bank. Then Second Republic Bank lends out all of its new excess reserves to Andrew, who writes a check to Teresa, who deposits the money into her account at Third Fidelity Bank. Third Fidelity lends out all of its new excess reserves to Beth in turn.
Fill in the following table to show the effect of this ongoing chain of events at each bank. Enter each answer to the nearest dollar.

Increase in Deposits.........Increase in Required...........Reserves Increase in Loans
........................................................(Dollars)........................ (Dollars).......................... (Dollars)
First Main Street Bank.............................?................................. ?...................................... ?
Second Republic Bank.............................. ?................................?......................................?
Third Fidelity Bank .......................................?...................................... ?..............................?

Assume this process continues, with each successive loan deposited into a checking account and no banks keeping any excess reserves. Under these assumptions, the $1,500,000 injection into the money supply results in an overall increase of( $750,000/ $6,000,000 / $7,500,000 ) in demand deposits.

Answer 1

(1) After the deposit of $1,500,000:

Assets	$	Liabilities	$
Reserves	1,500,000	Deposits	1,500,000

(2)

Assets	$	Liabilities	$
Change in required reserve	1,500,000 x 20% = 300,000	Amount deposited	$1,500,000
Change in required reserve	1,500,000 x 8% = 1,200,000

(3) After initial withdrawal:

(5) Initial injection of $1,500,000 leads to overall increase of $7,500,000 (= $1,500,000 / 0.2) in deposits.