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Economics 102 Spring 2006 Homework #5 Answers Due: April 27, 2006 1. Suppose Jeremy deposits \$100,000 in Wisconsin Bank, and Jason borrows \$75,000 from Wisconsin Bank to buy a car at the Ford dealership. Suppose the required reserve ratio for all banks (set by the Fed) is 25%. The Ford dealership deposits the money from Jason’s car purchase in Madison Credit Union. Assume that there are no currency drains and banks do not hold excess reserves. (a) Draw T-accounts for Wisconsin Bank, and Madison Credit Union. Wisconsin Bank‘s Balance Sheet Assets Liabilities Reserves: \$25,000 Demand Deposits: \$100,000 Loans: \$75,000 Madison Credit Union’s Balance Sheet Assets Liabilities Reserves: \$75,000 Demand Deposits: \$75,000 Loans: \$0 (b) What is the amount of required reserves held by Wisconsin Bank due to Jeremy’s deposit? What is the amount of required reserves held by Madison Credit Union after the Ford dealership’s deposit? Why are these amounts different? ANS: Wisconsin Bank’s RR = \$100,000 x 0.25 = \$25,000. Madison Credit Union’s RR= \$75,000 x 0.25 = \$18,750 These amounts differ, since Wisconsin Bank is only allowed to loan out their excess reserves. The required reserves for Madison Credit Union is only the required reserve ratio multiplied by the amount of the Ford dealership’s deposit. Suppose the Fed buys \$5000 worth of bonds from Barry, who banks at Madison Credit Union. In return for the bonds, it gives Barry a check for \$5000.

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