Question 15

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You must read each slide, and complete any questions on the slide, in sequence.

Assume that First Purity Bank begins with the balance sheet below and is fully loaned-up.

First Purity Bank | |||

Assets | Liabilities | ||

Reserves | $700,000 | Deposits | $2,000,000 |

Loans | $1,300,000 |

Incorrect! If the bank is fully loaned-up, its reserves are the minimum required. The reserve requirement is equal to reserves divided by deposits. Here, Reserves are $700,000 and Deposits are $2,000,000. Dividing these numbers, $700,000/$2,000,000 = 0.35 = 35%.

Correct! If the bank is fully loaned-up, its reserves are the minimum required. The reserve requirement is equal to reserves divided by deposits. Here, Reserves are $700,000 and Deposits are $2,000,000. Dividing these numbers, $700,000/$2,000,000 = 0.35 = 35%.

Incorrect! If First Purity Bank is to remain fully loaned-up, it will keep the minimum possible in reserves, thus loaning out the maximum possible. Multiply the $1 million new deposit by the reserve requirement, to determine the minimum required to be kept in reserves. Simply, 35% x $1,000,000 = $350,000. The remaining $650,000 can be loaned out.

Correct! If First Purity Bank is to remain fully loaned-up, it will keep the minimum possible in reserves, thus loaning out the maximum possible. Multiply the $1 million new deposit by the reserve requirement, to determine the minimum required to be kept in reserves. Simply, 35% x $1,000,000 = $350,000. The remaining $650,000 can be loaned out.

Incorrect! The potential money multiplier equals 1 divided by the reserve requirement. Since the reserve requirement equals 35% or 0.35, 1/0.35 ≈ 2.86.

Correct! The potential money multiplier equals 1 divided by the reserve requirement. Since the reserve requirement equals 35% or 0.35, 1/0.35 ≈ 2.86.

Incorrect! As the new deposit works through the banking system, 65% of each deposit will be loaned out again, with the remaining 35% placed into reserves. When First Purity Bank (Bank A) accepts the $1 million new deposit, it can loan out $650,000 and will place the remaining $350,000 into reserves. When the next bank, Bank B, accepts the $650,000 deposit, it can loan out $422,500 and must put $227,500 into reserves. A new deposit of $422,500 in Bank C will increase its total loans by $274,625 and total reserves by $147,875. These numbers become smaller and smaller, eventually approaching zero. In total (more than 50 transactions later), the total money supply will increase by $2.86 million. Thirty-five percent of this amount, or $1 million, is in required reserves, while the remaining $1.86 million is loaned out.

New Deposit x money multiplier = Maximum amount the money supply can increase $1 million x 2.86 = $2.86 million maximum possible increase in money supply.

Of this $2.86 million increase in the money supply, $1 million was the original new deposit. This means the fractional reserve banking system created $1.86 million in the form of new loans.

New Deposit x money multiplier = Maximum amount the money supply can increase $1 million x 2.86 = $2.86 million maximum possible increase in money supply.

Of this $2.86 million increase in the money supply, $1 million was the original new deposit. This means the fractional reserve banking system created $1.86 million in the form of new loans.

Correct! As the new deposit works through the banking system, 65% of each deposit will be loaned out again, with the remaining 35% placed into reserves. When First Purity Bank (Bank A) accepts the $1 million new deposit, it can loan out $650,000 and will place the remaining $350,000 into reserves. When the next bank, Bank B, accepts the $650,000 deposit, it can loan out $422,500 and must put $227,500 into reserves. A new deposit of $422,500 in Bank C will increase its total loans by $274,625 and total reserves by $147,875. These numbers become smaller and smaller, eventually approaching zero. In total (more than 50 transactions later), the total money supply will increase by $2.86 million. Thirty-five percent of this amount, or $1 million, is in required reserves, while the remaining $1.86 million is loaned out.

New Deposit x money multiplier = Maximum amount the money supply can increase $1 million x 2.86 = $2.86 million maximum possible increase in money supply.

Of this $2.86 million increase in the money supply, $1 million was the original new deposit. This means the fractional reserve banking system created $1.86 million in the form of new loans.

New Deposit x money multiplier = Maximum amount the money supply can increase $1 million x 2.86 = $2.86 million maximum possible increase in money supply.

Of this $2.86 million increase in the money supply, $1 million was the original new deposit. This means the fractional reserve banking system created $1.86 million in the form of new loans.