ECMA06_Tutorial_9_Solution

# ECMA06_Tutorial_9_Solution - ECMA06 Tutorial #9 Answer Key...

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Question 1 Part (a) Desired reserves: Desired reserves = reserve ratio (rr) × demand deposits (DD) Desired reserves = 0.125 × \$3600 = \$450 Excess reserves: Excess reserves = actual reserves held by chartered bank – desired reserves Excess reserves = \$500 - \$450 = \$50 The chartered bank holds excess reserves of \$50. Part (b) Suppose the chartered bank keeps the level of excess reserves constant at \$50 and the central bank purchases \$25 of government bonds from the public (we called this open market purchase): The chartered bank’s balance sheet– Beginning Assets Liabilities Cash & reserves \$500 Demand deposits \$3600 Loans \$4000 Equity \$900 The chartered bank’s balance sheet– Final Assets Liabilities Cash & reserves \$500+\$25 = \$525 Demand deposits \$3600 + \$25/0.125 = \$3800 Loans \$4000 + (\$200 – \$25) = \$4175 Equity \$900 The chartered bank’s reserves increases by \$25. Loans made by the chartered bank rises by \$175. Demand deposits increases by \$200. Money supply increases by \$200, as demand deposits increases by \$200. FYI: How MS increases? When the central bank purchases \$25 of government bonds form the public, those who sell the bonds to the central bank will receive cheques form the central bank (a total amount of \$25). These bond sellers deposit their cheques to the chartered banks; demand deposits immediately increase by \$25 and so does the reserves held by the chartered bank. Given the reserve ratio is 12.5% and there are \$25 new demand deposits, the chartered bank only needs to hold \$3.125 (\$25 × 0.125) as reserves to meet its target but the chartered bank finds its reserves increases by \$25 and has additional excess reserves of \$21.875 the chartered bank gets rid of these additional excess reserves by making loans to the public loans begin to increases. The lent out money ends up being redeposited back in the chequing accounts (demand deposits), and the above process continues until the excess reserves of the chartered bank return to their previous level (i.e., \$50) when the demand deposits increase by \$200. ECMA06 Tutorial #9 Answer Key

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## This note was uploaded on 12/21/2011 for the course ECONOMICS ECMA06 taught by Professor Dr.atamazaheri during the Spring '10 term at University of Toronto.

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ECMA06_Tutorial_9_Solution - ECMA06 Tutorial #9 Answer Key...

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