In exchange for his many years of hard work and devotion, National Corp Inc. giv
ID: 1198026 • Letter: I
Question
In exchange for his many years of hard work and devotion, National Corp Inc. gives Dave $100,000 in T-bonds. Dave sells these bonds to the Fed, and the Fed deposits the money in Dave's bank account.
A. By how much does the money supply change as a result of this deposit into Dave's account from the Fed? Explain. (3 points)
B. A bank's actual reserve ratio is the percentage of total deposits a bank actually holds on to. It is made up of the percentage they are required to hold on to, known as the required reserve ratio, plus any extra they choose to hold on to. Suppose Dave's bank has an actual reserve ratio of 12%, and his bank makes a loan to Darlene based on the funds from Dave's deposit. How much does the money supply increase as a result of this second step? (3 points)
C. Darlene uses the money to buy a very expensive pair of soccer cleats from Arthur. Arthur deposits this money in his bank account. His bank holds onto 12% of the deposit and lends the rest out. How much does the money supply increase as a result of this step? (4 points)
D. In total, by what amount does the original $100,000 that the Fed released into circulation end up increasing the money supply if every bank holds 12% of its deposits? (4 points)
E. This example shows the increase in the money supply caused by an increase in bank deposits. Explain why this activity by banks is called money creation. (5 points)
Explanation / Answer
Solution 1:
When the Fed purchases the T-bond from Dave, it is pumping money into the economy ($100,000) that wasn't in circulation prior to the purchase. When the Fed purchases T-Bills, it is an expansionary action meaning the money supply has increased by $100,000.
Solution 2:
Post keeping 12% of 100000 the remaining amount is 88000 which is added to money supply for circulation.
Solution 3:
Post keeping 12% of 88000 the remaining amount is 77440 which is added to money supply for circulation.
Solution 4:
A total of 165440 (88000+77440) is added to money supply from original 100000 through the banks inlovlved.
Solution 5:
Money creation: The process whereby banks make loans equal to the amount of their excess reserves and create new checkbook money is known as multiple deposit creation. Each time a bank receives a deposit, it sets aside some of it to meet reserve requirements and may lend an amount equal to the remaining excess reserves.
It is called money creation as it increase money supply by the excess amount the bank has for loans and advances which additionally increase the money supply by amount of interest occured from the loans issued to customers.