Question

Background

Sarah Saver goes to Fancy National Bank and deposits $1,000 that she earned from her summer job. She now has a checking account with a balance of $1,000 from which she can write checks. Fancy National Bank has a 10 percent reserve requirement. The bank will put $100 in its vault and lend out the rest to people who need loans.

If you recall from the lesson, fractional reserve banking is a banking system in which only a fraction of bank deposits are actual cash-on-hand and available for withdrawal; this helps expand the economy by freeing up capital that can be loaned out to other parties.

Part One (2.5 points)

Ernie Entrepreneur walks into Fancy National Bank wanting to borrow $900 to start his new catering business. If the bankers decide that his project is worthwhile and he meets its criteria for a loan, the bank will loan him the $900. If Ernie puts the $900 in his checking account, he can then write checks for that amount. There is now $1,900 of money available ($1,000 in Sarah’s checking account and $900 in Ernie’s account) to be spent. In other words, $900 of new money has been created.

1- If Ernie next deposits a profit of $500 from the grand opening of his business, the money supply is now this amount:

Part Two (2.5 points)

2- Mark Merchant needs to borrow money for his business. The bank has $10,000 in deposits. Remembering the 10 percent reserve requirement, what is the maximum that the bank can loan Mark?

Part Three (5 points)

3- now that Mark Merchant has secured a loan for his business, how might he use that loan? Give two examples of how he could use the loan for improving his business, and explain how each example will have an effect in the economy.   

Part Four (5 points each)

In this section you will summarize what you have learned about the Federal Reserve. Answer each of the following questions in 3-4 sentences each:

4- Explain the roles and responsibilities of the Federal Reserve System.

5- Compare and contrast the consequences – intended and unintended – of different monetary policy actions of the Federal Reserve Board to achieve macroeconomic goals of stable prices, low unemployment, and economic growth. What effects can occur with different Federal Reserve actions (such as increasing money supply or raising interest rates)?

Answer 1

1. If Ernie deposits $500 in the bank, money supply will increase by 90% of $500 i.e $450. So, total money supply in the market will be 1900 + 450 = $2350.

2. Bank can loan a maximum of 90% of $10,000 i.e $9000.

3. Mark can improve his business in following ways.

a) Invest in marketing his business. Effective marketing has a high ROI. It will increase Mark's sales and will help in improving his services. Increased spending and increased sales will help increase Jobs, reduce unemployment in the market and eventually help increase the GDP of the country.

b) Expand his operations to other cities. This will again help him improve his sales and earn higher profits. Increased Sales help in eventually increasing the GDP of the country.

4. Following are the 5 main functions of Federal Reserve System.

i) Conducting Monetary Policy : This the main Function.It is the actions taken by the Federal Reserve to influence the supply of money and credit in order to promote price stability and maintain maximum sustainable economic growth.

ii) Promoting Financial System Stability. For this Federal Reserve closely monitors the links between investors, Savers, Borrowers and Business in US and abroad.

iii) Supervising and regulating financial institutions and activities

iv) Fostering payment and settlement system safety and efficiency

v) Promoting consumer protection and community development