Question 3 (13 marks)

Suppose that in a country households hold no currency. The total holdings of its banking system were as follows:

Deposits = $2,000 million Loans = $1,550 million Reserves = $350 million

Investment in government bonds = $600 million Bank capital = ?

(a)Prepare the balance sheet that shows the assets, liabilities, and bank capital. (4 marks)

(b)What is the current leverage ratio of this banking system? And if the value of its investment in government bonds drops to $400 million, by what percentage does the banks' capital decline? (2 marks)

(c)Suppose that the central bank requires banks to hold 10% of deposits as reserve. How much in excess reserve is there in banking system? And if all banks would now decide to reduce its reserves to only the required amount, by how much (at most) would the economy's money supply increase? (2 marks)

(d)Suppose that the central bank buys back the government bonds from banks for $200 million. For this action alone, what would be the maximum potential impact to the economy's money supply if all banks keep the reserve ratio of 10%? (2 marks)

(e)Identify three other methods that the central bank could use to increase money supply, except the open market operation (OMO) mentioned in part (d). (3 marks)