Question
Question 1. (76 pts) Assume that there is only one private bank whose equity or net worth is always zero. Also maintain the following assumptions:
Question 1. (76 pts) Assume that there is only one private bank whose equity or net worth is always zero. Also maintain the following assumptions:
(A1) The ratio of cash holdings by the non-bank public to demand deposits is 005, and all bank liabilities are demand deposits;
(A2) The bank keeps the reserve/deposit ratio at 01; (A3) Demand deposits, bank loans and Treasury securities bear zero net interest.
Use the notation for the non-bank publics cash holdings, for demand deposits, for bank reserves, and for bank loans. Round up all dollar amounts to 001 billion.
(1) (20 pts) Assume that the initial monetary base is = $15 billion and that the bank holds $20 billion Treasury securities. In addition to the Treasuries, the banks assets are loans to the private sector and bank reserves. Suppose that the cash/deposit ratio has reached 005 and the reserve ratio has reached 01. Calculate the non-bank publics cash holdings, deposits, bank reserves, bank loans, and the money stock 1. Fill in the banks balance sheet with the corresponding items.
(2) (15 pts) Suppose that the government increases the reserve requirement to 015. After the cash/deposit ratio has reached 005 and the reserve ratio has reached 015, recal- culate the non-bank publics cash holdings, deposits, bank reserves, and bank loans. By how much does 1 fall?
For the remainder of Question 1, go back to the assumption that the reserve requirement is 01. Start in the situation reached in (1) above. Consider an open market operation in which the bank sells $20 billion Treasuries to the Federal Reserve and lends the proceeds of the sale to the private sector.
(3) (5 pts) Fill in the banks balance sheet at the time before the private sector deposits any part of the money from the $20 billion loans back in the bank.
(4) (21 pts) The private sector deposits part of the $20 billion loans back to the bank following the rule (A1). In turn, the bank lends out part of the new deposits and keeps the reserve ratio at 01. After this new round of bank lending but before any of the new loans in this round are deposited back in the bank, calculate demand deposits, bank reserves, bank loans, the publics cash holdings, and the money stock M1. Fill in the banks balance sheet after this round of activities.
(5) (15 pts) Suppose that the cash/deposit ratio finally settles at 005 and the reserve ratio settles at 01. Calculate demand deposits, bank reserves, bank loans, and the publics cash holdings. By how much has the open market operation increased the money stock M1?
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