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32-.

32-3

(Key Question) Why does the Federal Reserve require commercial banks to have reserves? Ex lain !hy reserves are an asset to commercial banks but a liability to the Federal Reserve "anks# What are excess reserves? $o! do you calculate the amount o% excess reserves held by a bank? What is the si&ni%icance o% excess reserves? Reserves rovide the Fed a means o% controllin& the money su ly# 't is throu&h increasin& and decreasin& excess reserves that the Fed is able to achieve a money su ly o% the si(e it thinks best %or the economy# Reserves are assets o% commercial banks because these %unds are cash belon&in& to them) they are a claim the commercial banks have a&ainst the Federal Reserve "ank# Reserves de osited at the Fed are a liability to the Fed because they are %unds it o!es) they are claims that commercial banks have a&ainst it# Excess reserves are the amount by !hich actual reserves exceed required reserves* Excess reserves* Excess reserves + actual reserves - required reserves# ,ommercial banks can sa%ely lend excess reserves- thereby increasin& the money su ly# (Key Question) /When a commercial bank makes loans- it creates money) !hen loans are re aid- money is destroyed#0 Ex lain# "anks add to checkin& account balances !hen they make loans) these checkable de osits are art o% the money su ly# 1eo le ay o%% loans by !ritin& checks) checkable de osits %all- meanin& the money su ly dro s# 2oney is /destroyed#0 (Key Question) 4u ose that ,ontinental "ank has the sim li%ied balance sheet sho!n belo! and that the reserve ratio is 25 ercent* Liabilities and net worth (1) (2) hec!able de"osits $100,000 ##### #####

Assets (1) (2) Reserves Securities Loans $22,000 38,000 40,000

a# What is the maximum amount o% ne! loans that this bank can make? 4ho! in column 6 ho! the bank7s balance sheet !ill a ear a%ter the bank has lent this additional amount# b# "y ho! much has the su ly o% money chan&ed? Ex lain# c# $o! !ill the bank7s balance sheet a ear a%ter checks dra!n %or the entire amount o% the ne! loans have been cleared a&ainst this bank? 4ho! this ne! balance sheet in column 2# d# 8ns!er questions a- b- and c on the assum tion that the reserve ratio is 69 ercent# (a) :2-555# ,olumn 6 o% 8ssets (to to bottom)* :22-555) :33-555) :.2-555# ,olumn 6 o% ;iabilities* :652-555# (b) :2-555# <he bank has lent out its excess reserves- creatin& :2-555 o% ne! demandde osit money# (c) ,olumn 2 o% 8ssets (to to bottom)* :25-555) :33-555) :.2-555# ,olumn 2 o% ;iabilities) :655-555#

(d) (a) :=-555# ,olumn 6 o% 8ssets (to to bottom)* :22-555) :33-555) :.=-555# ,olumn 6 o% ;iabilities* :65=-555# (b) :=-555 (c) ,olumn 2 o% 8ssets (to to bottom)* :69-555) :33-555) :.=-555# ,olumn 6 o% ;iabilities* :655-555# 32-63 (Key Question) 4u ose the sim li%ied consolidated balance sheet sho!n belo! is %or the entire commercial bankin& system# 8ll %i&ures are in billions# <he reserve ratio is 29 ercent# Assets (1) Reserves Securities Loans $ &2 ### 48 ### 100 ### hec!able de"osits Liabilities and $et %orth (2) $200 ###

a# What amount o% excess reserves does the commercial bankin& system have? What is the maximum amount the bankin& system mi&ht lend? 4ho! in column 6 ho! the consolidated balance sheet !ould look a%ter this amount has been lent# What is the monetary multi lier? b# 8ns!er the questions in art a assumin& that the reserve ratio is 25 ercent# Ex lain the resultin& di%%erence in the lendin& ability o% the commercial bankin& system# (a) Required reserves + :95 billion (+ 29> o% :255 billion)) so excess reserves + :2 billion (+ :92 billion - :95 billion)# 2aximum amount bankin& system can lend + :3 billion (+ 6?#29 :2 billion)# ,olumn (6) o% 8ssets data (to to bottom)* :92 billion) :.3 billion) :653 billion# ,olumn (6) o% ;iabilities data* :253 billion# 2onetary multi lier + . (+ 6?#29)# (b) Required reserves + :.5 billion (+ 25> o% :255 billion)) so excess reserves + :62 billion (+ :92 billion - :.5 billion)# 2aximum amount bankin& system can lend + :@5 billion (+ 6?#25 :62 billion)# ,olumn (6) data %or assets a%ter loans (to to bottom)) :92 billion) :.3 billion) :6@5 billion# ,olumn (6) data %or liabilities a%ter loans* :2@5 billion# 2onetary multi lier + 9 (+ 6?#25)# <he decrease in the reserve ratio increases the bankin& system7s excess reserves %rom :2 billion to :62 billion and increases the si(e o% the monetary multi lier %rom . to 9# ;endin& ca acity becomes 9 :62 + :@5 billion#