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Suppose banks keep no excess reserves and that all banks are currently meeting the reserve requirement. The Federal Reserve then makes an open market purchase of $16 , 000
from Bank 1.
Use the T-account below to show the result of this transaction for Bank 1, assuming Bank 1 keeps no excess reserves after the transaction. (Remember T-accounts show the changes to a bank's balance sheet.)
The simple deposit multiplier is used to determine the total increase in deposits and the money supply:
total increase in deposits = change in bank reserves/rr
The higher the required reserve ratio, the smaller is the simple deposit multiplier.
When RR = 10%, the multiplier is 10 and the total increase in deposits is $10,000. 10 x 1k
The total increase in the money supply is $10,000minus
$1,000equals$9,000.
This process also works in reverse: when banks lose reserves, they
reduce their loans and the money supply contracts.
Assume all of Bank 1's loans of $16,000
are spent by the borrowers and then deposited into Bank 2.
Use the T-account below to show the result of this transaction for Bank 2, assuming Bank 2 keeps no excess reserves and the reserve requirement is 9
%.
(Remember T-accounts show the changes to a bank's balance sheet.)
Assume all of Bank 2's loans of $14 comma 560
are spent by the borrowers and then deposited into Bank 3.
Use the T-account below to
show the result of this transaction for Bank 3, assuming Bank 3 keeps no excess reserves and the reserve requirement is 9
%.
(Remember T-accounts show the changes to a bank's balance sheet.)
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