Work It Out Chapter 14(29)

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Work It Out

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Show the changes to the T-accounts for the Federal Reserve and for commercial banks when the Federal Reserve buys $50 million in U.S. Treasury bills. If the public holds a fixed amount of currency (so that all loans create an equal amount of deposits in the banking system), the minimum reserve ratio is 10%, and banks hold no excess reserves.

Show the initial change in the balance sheet for Federal Reserve (use + to indicate an increase and – to indicate a decrease).

Assets	Liabilities
Treasury Bills $ million	Monetary Base $ million

Table

When the Federal Reserve buys $50 million in Treasury bills from commercial banks, its assets increase by $50 million (it now owns $50 million in Treasury bills) but its liabilities also increase by $50 million as it credits the banks’ accounts at the Federal Reserve, part of the monetary base. For further review see section, “Open Market Operations.”

Show the initial change in the balance sheet for Federal Reserve (use + to indicate an increase and – to indicate a decrease).

1:13

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Show the initial change in the balance sheet for commercial banks (use + to indicate an increase and – to indicate a decrease).

Assets		Liabilities
Reserves	$ million
Treasury Bills	$ million

Table

Commercial banks' assets fall by $50 million because they sell Treasury bills to the Fed, but their assets also rise by $50 million when their deposits at the Fed (reserves) are credited with $50 million. For further review see section, “Open Market Operations.”

Show the initial change in the balance sheet for commercial banks (use + to indicate an increase and – to indicate a decrease).

0:49

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Show the final balance sheet for commercial banks after the money creation process (use + to indicate an increase and – to indicate a decrease).

Assets		Liabilities
Reserves	$ million	Checkable deposits $ million
Treasury Bills	$million
Loans	$million

Table

The total change in the money supply is: $ million.

After the Federal Reserve buys $50 million from commercial banks, the banks are holding $50 million in excess reserves. Since the banks do not want to hold any excess reserves you can use the money multiplier (1/required reserve rate) to find the change in checkable deposits and the money supply. Since the reserve rate is 10%, the money multiplier is 10. The change in checkable deposits will be 10 times the change in reserves or 10 x $50M. In total commercial banks will increase loans and deposits by $500 million, the maximum amount that $50 million in reserves can support. Therefore, the money supply will also increase by $500 million. For further review see section, “Open Market Operations.”

Show the final balance sheet for commercial banks after the money creation process (use + to indicate an increase and – to indicate a decrease).

2:19

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Work It OutChapter 14(29)

Question 1 of 3

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