Question

The money supply expansion process

Suppose First Main Street Bank, Second Republic Bank, and Third Fidelity Bank all have zero excess reserves. The required reserve ratio is 20%. The Federal Reserve buys a government bond worth $750,000 from Raphael, a client of First Main Street Bank. He deposits the money into his checking account at First Main Street Bank.

Complete the following to reflect any changes in First Main Street Bank's balance sheet (before the bank makes any new loans).

a) The Assets side of First Main Street Bank's balance sheet (before the bank makes any new loans), this (increases/decreases) First Main Street Bank's (building and furniture/net worth/checkable deposits/reserves/loans) by ($150,000/$600,000/$750,000/$1,800,000). On the Liabilities side, First Main Street Bank's balance sheet, (increases/decreases) First Main Street Bank's (building and furniture/net worth/checkable deposits/reserves/loans) by ($150,000/$600,000/$750,000/$1,800,000).

b) Complete the following table to show the effect of a new deposit on excess and required reserves when the required reserve ratio is 20%.

Hint: If the change is negative, be sure to enter the value as a negative number.

Amount Deposited	Change in Excess Reserves	Change in Required Reserves
(Dollars)	(Dollars)	(Dollars)
750,000

c) Now, suppose First Main Street Bank loans out all of its new excess reserves to Megan, who immediately writes a check for the full amount to Larry. Larry then immediately deposits the funds in his checking account at Second Republic Bank. Then Second Republic Bank lends out all of its new excess reserves to Raphael, who writes a check to Susan, who deposits the money in her account at Third Fidelity Bank. Finally, Third Fidelity lends out all of its new excess reserves to Becky.

Fill in the following table to show the effect of this ongoing chain of events at each bank. Enter each answer to the nearest dollar.

	Increase in Checkable Deposits	Increase in Required Reserves	Increase in Loans
	(Dollars)	(Dollars)	(Dollars)
First Main Street Bank
Second Republic Bank
Third Fidelity Bank

d) Assume this process continues, with each successive loan deposited into a checking account and no banks keeping any excess reserves. Under these assumptions, the $750,000 injection into the money supply results in an overall increase of ($370,000/$3,000,000/$3,750,000) in checkable deposits.