After the public withdraws $50 million in deposits to hold as currency, the T-accounts look
like this:
Banking System (all five banks)
Assets
Liabilities
Reserves
Loans (borrowings from the Fed)
million
million
Federal Reserve System
Assets
Liabilities
Loans (borrowings from the Fed)
million
Reserves
Currency
Public
Assets
Liabilities
million
million
19. Using T-accounts, show what happens to checkable deposits in the banking system when the
Fed lends $1 million to the First National Bank.
Federal Reserve System
Assets
Loans (borrowings from the Fed)
Banking System
Assets
Liabilities
Reserves
Loans (borrowings from the Fed)
million
Federal Reserve System
Assets
Liabilities
Loans (borrowings from the Fed)
Reserves
Banking System
Assets
Liabilities
Reserves
Loans (borrowings from the Fed)
million
Loans
million
20. Using T-accounts, show what happens to checkable deposits in the banking system when the
Fed sells $2 million of bonds to the First National Bank.
Federal Reserve System
Assets
Liabilities
Securities
Reserves
Banking System
Assets
Liabilities
Securities
Reserves
Federal Reserve System
Assets
Liabilities
Securities
Reserves
Banking System
Assets
Liabilities
Securities
Checkable Deposits
million
Reserves
Loans
21. If the Fed buys $1 million of bonds from the First National Bank, but an additional 10% of
any deposit is held as excess reserves, what is the total increase in checkable deposits?
(Hint: Use T-accounts to show what happens at each step of the multiple expansion process.)
The total increase in checkable deposits is only $5 million, substantially less than the $10
Federal Reserve System
Assets
Liabilities
Securities
million
Reserves
Banking System
Assets
Liabilities
Securities
Reserves
After the increase in reserves and the multiple deposit creation process, the Fed and Banking
system balance sheets are as follows:
Federal Reserve System
Assets
Liabilities
Securities
Reserves million
Banking System
Assets
Liabilities
Securities
million
Reserves
22. If reserves in the banking system increase by $1 billion because the Fed lends $1 billion to
financial institutions, and checkable deposits increase by $9 billion, why isn’t the banking
system in equilibrium? What will continue to happen in the banking system until equilibrium
is reached? Show the T-account for the banking system in equilibrium.
Banking System
Assets
Liabilities
Reserves
Loans (borrowings from the Fed)
billion
Loans
Checkable deposits
23. If the Fed reduces reserves by selling $5 million worth of bonds to the banks, what will the T-
account of the banking system look like when the banking system is in equilibrium? What will
have happened to the level of checkable deposits?
Checkable deposits will decrease by $50 million when the banking system is in equilibrium (as
a result of the $5 million decrease in reserves supporting the money supply). The T-account
is shown below:
Banking System
Assets
Liabilities
Reserves
Securities
Checkable deposits
million
Loans
24. If the Fed sells $1 million of bonds and banks reduce their borrowings from the Fed by $1
million, predict what will happen to the money supply.
25. Suppose that currency in circulation is $600 billion, the amount of checkable deposits is
$900 billion, and excess reserves are $15 billion.
a. Calculate the money supply, the currency deposit ratio, the excess reserve ratio, and the
money multiplier.
c
b. Suppose the central bank conducts an unusually large open market purchase of bonds
held by banks of $1400 billion due to a sharp contraction in the economy. Assuming the
ratios you calculated in part (a) remain the same, predict the effect on the money supply.
c. Suppose the central bank conducts the same open market purchase as in part (b), except
that banks choose to hold all of these proceeds as excess reserves rather than loan them
out, due to fear of a financial crisis. Assuming that currency and deposits remain the
same, what happens to the amount of excess reserves, the excess reserve ratio, the money
supply, and the money multiplier?
ER e m
d. During the financial crisis in 2008, the Federal Reserve began injecting the banking
system with massive amounts of liquidity, and at the same time, very little lending
occurred. As a result, the M1 money multiplier was below 1 for most of the time from
October 2008 through 2011. How does this scenario relate to your answer to part (c)?
ANSWERS TO DATA ANALYSIS PROBLEMS
1. Go to the St. Louis Federal Reserve FRED database, and find the most current data
available on Currency (CURRNS), Total Checkable Deposits (TCDNS), Total Reserves
(RESBALNS), and Required Reserves (RESBALREQ).
a. Calculate the value of the currency deposit ratio c.
b. Use RESBALNS and RESBALREQ to calculate the amount of excess reserves, and then
calculate the value of the excess reserve ratio e. Be sure the units of total and required
reserves are the same when you do the calculations.
c. Assuming a required reserve ratio rr of 11%, calculate the value of the money multiplier
m.
2. Go to the St. Louis Federal Reserve FRED database, and find data on the M1 Money Stock
(M1SL) and the Monetary Base (AMBSL).
a. Calculate the value of the money multiplier using the most recent data available and the
data from five years prior.
b. Based on your answer to part (a), how much would a $100 million open market purchase
of securities affect the M1 money supply today and five years ago?