Initially, the Republic of Gorgonzola has no commercial banking system. Then, the government directs the central bank of Gorgonzola to put into circulation a million identical paper notes, called guilders. The central bank prints the guilders and distributes them to the population. In order to safeguard the money, some Gorgonzolan entrepreneurs set up a system of commercial banks. When people need to make a payment, they can either withdraw their guilders or, more conveniently, write a check on their account. Checks give the banks permission to transfer guilders from the account of the person paying by check to the account of the person to whom the check is made out. With a system of payments based on checks, the paper guilders need never leave the banking system, although they flow from one bank to another as a depositor of one bank makes a payment to a depositor in another bank. Deposits do not pay interest in this economy.

Let’s suppose for now that people prefer bank deposits to cash and so deposit all of their guilders with the commercial banks.

Assume that (1) initially, the Gorgonzolan central bank puts 2,000,000 guilders into circulation and (2) commercial banks desire to hold reserves of 5 percent of deposits. Assume that the public holds no currency.

Instructions: Enter your responses as integer values.

a. The consolidated balance sheet of Gorgonzolan commercial banks after the initial deposits is:

Balance sheet after initial deposits

Assets: Currency____

Liabilities: Deposits____

b. The consolidated balance sheet of Gorgonzolan commercial banks after one round of loans is:

Balance sheet after first round of loans

Assets: Currency(= reserves)_____

Assets: Loans______

Liabilities: Deposits____

c. The consolidated balance sheet of Gorgonzolan commercial banks after the first redeposit of guilders is:

Balance sheet after redeposits

Assets: currency (=reserves)___

Loans_____

Liabilities: Deposits____

d. The consolidated balance sheet of Gorgonzolan commercial banks after two rounds of loans and redeposits is:

Balance sheet after second round of loans and redeposits

Assets:

Currency (=reserves) _____

Loans_____

Liabilites:

Deposits____

e. The final values of bank reserves, loans, deposits, and the money supply are:

Final consolidated balance sheet

Assets: Currency (final value of bank reserves) _____

Assets: loans____

Liabilities: Deposits

MONEY SUPPLY: ______ guilders