Example for Financial Accounting

Topics: Fractional-reserve banking, Federal Reserve System, Central bank Pages: 2 (367 words) Published: April 2, 2013
You take $100 you had kept under your pillow and deposit it in your bank account. Case 1: If this $100 stays in the banking system as reserves Deposits rise by $100 and money supply is unchanged (because currency declines by $100 and total deposit rises by $100)

Case 2: If banks hold reserves equal to 10% of deposits
The total amount of deposits in the banking system increases by $1,000, because a reserve ratio of 10% means the money multiplier is 1/.10 = 10. Thus, the money supply increases by $900, because deposits increase by $1,000 but currency declines by $100.

First National Bank: Deposits: $500,000, Reserves: $100,000, Loans: $400,000 If Fed requires banks to hold 5% of deposits as reserves, the excess reserves First national now hold are $75,000( $100,000 minus $25,000).

Assume that all other banks hold only the required amount of reserves. If First national decides to reduce its reserves to only the required amount, then First National bank can lend out its excess reserves of $75,000. With a required reserve ratio of 5%, the money multiplier is 1/.05 = 20. Therefore, the money supply will eventually increase by $75,000 x 20 = $1500,000.

Assume that the banking system has total reserves of $100 billion (according to author’s answers, this means banking system has total of $100 billion available for loaning out). Assume the required reserve ratios are 10% and banks hold no excess reserves and households hold no currency.

Because the required reserves are $10 billion, banking system can loan out $90 billion. This loan of $90 billion will create $90/0.1=$900 billion more deposits. The money multiplier is 1/0.1=10. The money supply is $100 (original)+$900 (created)=$1000 billion. (You can also calculate the money supply by using $100/0.1=$1000 billion). If the required reserve ratio is raised to 20%, the money multiplier declines to 1/.20 = 5. The money supply would become $500 billion.

Reserves would be unchanged....
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