National Bank currently has $500 million in transaction deposits on its balance sheet. The current reserve requirement is 10 percent, but the Federal Reserve is decreasing this requirement to 8 percent.

a. Show the balance sheet of the Federal Reserve and National Bank if National Bank converts all excess reserves to loans, but borrowers return only 50 percent of these funds to National Bank as transaction deposits.

b. Show the balance sheet of the Federal Reserve and National Bank if National Bank converts 75 percent of its excess reserves to loans and borrowers return 60 percent of these funds to National Bank as transaction deposits.

CORRECT ANSWER:

Panel A (for both parts)

Federal Reserve Bank

Assets

Securities: $50 million

Liabilities

Reserve Accounts: $50 million

National Bank

Assets

Loans: $450 million

Reserve Deposits at Fed $50 million

Liabilities

Transaction Deposits: $500 million

a. Panel B: Balance sheet after all changes resulting from decrease in reserve requirement New initial required reserves = 0.08 $500 million = $40 million Change in bank deposits = (1/(0.08 + (1 0.5))) ($50 million $40 million) = $17.241 million Loans: $517.241 million $41.379 million = $475.862 million Transaction deposits: $500 million + ($10 (1/(0.08 + 0.5))) = $517.241 million Reserve deposits at Fed: $517.241 million 0.08 = $41.379 million b. Panel B: Balance sheet after all changes resulting from decrease in reserve requirement New initial required reserves = 0.08 $500 million = $40 million Change in bank deposits = (1/(0.08 + (1 0.6))) ($50 million $40 million) 0.75 = $15.625 million Loans: $515.625 million $41.25 million = $474.375 million Transaction deposits: $500 million + ($10 0.75 (1/(0.08 + 0.4))) = $515.625 million Reserve deposits at Fed: $515.625 million 0.08 = $41.25 million