Assume that the Fed purchases a security for $12,500 from FirstBank. Also assume
ID: 1176558 • Letter: A
Question
Assume that the Fed purchases a security for $12,500 from FirstBank. Also assume that the reserve ratio is 0.2 (20%). FirstBank lends its excess reserves to Betty, who does her banking at SecondBank. SecondBank lends its excess reserves to Charlie, who does his banking at ThirdBank. ThirdBank lends its excess reserves to Donna, who does her banking at FourthBank. Assume a simple money creation model, with no cash drain, no time deposits, and banks desire to hold no excess reserves. How does the open market purchase affect the T-accounts for FirstBank, SecondBank and ThirdBank? What is the total increase in deposits that results from the initial change in reserves?Explanation / Answer
Fed purchase $12,500 from FirstBank
FirstBank T-account
A L
Sec -12500 Deposits 12,500
Reserves 2,500
Loans 10,000
SecondBank T-account
A L
Sec. 10,000 Deposits 10,000
Reserves 2,000
Loans 8,000
ThirdBank T-Account
A L
Sec. 8,000 Deposits 8,000
Reserves 1,600
Loans 6,400
FourthBank T-account
A L
Sec. 6,400 Deposits 6,400
Reserves 1,280
Loans 5,120
Therefore total increase in deposits = 12,500 + 10,000+ 8,000+ 6,400=$36,900