In the tables that follow you will find consolidated balance sheets for the comm
ID: 1117616 • Letter: I
Question
In the tables that follow you will find consolidated balance sheets for the commercial banking system and the 12 Federal Reserve Banks. Use columns 1 through 3 to indicate how the balance sheets would read after each of transactions a to c is completed. Do not cumulate your answers; that is, analyze each transaction separately, starting in each case from the numbers provided. All accounts are in billions of dollars. a. A decline in the discount rate prompts commercial banks to borrow an additional $5 billion from the Federal Reserve Banks. Show the new balance-sheet numbers in column 1 of each table. b. The Federal Reserve Banks sell $7 billion in securities to members of the public, who pay for the bonds with checks. Show the new balance-sheet numbers in column 2 of each table. c. The Federal Reserve Banks buy $6 billion of securities from commercial banks. Show the new balance-sheet numbers in column 3 of each table. Instructions: Enter your answers as whole numbers in the gray-shaded cells in both tables below. d. Now review each of the above three transactions, asking yourself these three questions: (1) What change, if any, took place in the money supply as a direct and immediate result of each transaction? (2) What increase or decrease in the commercial banks’ reserves took place in each transaction? (3) Assuming a reserve ratio of 20 percent, what change in the money-creating potential of the commercial banking system occurred as a result of each transaction? Transaction a: 1. The money supply . 2. Reserves from $34 to $ billion. 3. Money-creating potential by $ billion. Transaction b: 1. The money supply by $ billion. 2. Reserves from $34 to $ billion. 3. Money-creating potential by $ billion. Transaction c: 1. The money supply . 2. Reserves from $34 to $ billion. 3. Money-creating potential by $ billion.
Explanation / Answer
A. A decline in discount rate prompts commercial banks to borrow an additional $5 Billion from the Federal Reserve Banks.
1. As a result of this transaction, now the commercial banks have more funds to provide loans to the public. Hence the money supply in an economy would increase.
2. A $5 Billion increase in the reserves of the commercial banks takes place in this transaction,i.e, $34 Billion+$5 Billion= $39 Billion.
3. 20% of $5 Billion is $1 Billion. Hence $4 Billion would be available for money creation.
B. The Federal Reserve Banks sell $7 billion in securities to the members of the public, who pay for the bonds in cheques.
1. As a result of this transaction, the money supply in the economy would reduce.
2. The reserves of the commercial banks would increase by $7 Billion, i.e, $34 Billion+$7 Billion= $41 Billion.
3. The money creation potential of the commercial banks would increase by $5.6 Billion
C. The Federal Reserve Banks buy $6 billion of securities from commercial banks. The commercial banks get excess reserves which they use for providing loans to the public/commercial sector.
1. Thus the money supply in the economy increases.
2. The reserves of the commercial banks would increase by $6 Billion, i.e, $34 Billion +$6 Billion = $40 Billion.
3. The money creation potential of the commercial banks increses by $4.8 Billion.