Part -1:

A) Money Creation by a Single Bank

1. Given a bank with only the following items on its balance sheet: $4000 of Reserves and $4000 of Deposits. The reserve ratio (R) = .20.

a) List the assets and liabilities on the bank's balance sheet. What is the amount of excess reserves?

b) What is the maximum amount of loans it can make? List the items on the bank's balance sheet after it has made these loans (but before any checks on the proceeds of the loans have cleared). By how much has the money supply changed?

c) List the items on the bank's balance sheet after checks have been drawn on the proceeds of the loans and the checks have cleared.

d) List the items on the bank's balance sheet (after checks have been drawn and cleared) if it had used its excess reserves to purchase securities rather than make loans.

2. Answer question #1 (parts a through c) if the reserve ratio = .10.

B) The Banking System and the Money Multiplier

Assume the balance sheet in question #1 represents the entire banking system rather than a single bank (which means you need to use the money multiplier). What is the maximum amount of deposits and lending that can be supported by the $4000 of reserves in the banking system (R = .20). List the items on the banking system's balance sheet with this maximum amount of loans and deposits.

Part -2:

Open Market Operations

1. If the banking system is currently holding the following: $1000 of reserves, $1500 of government securities, $2500 of loans, and $5000 of deposits, and the Reserve Ratio = .20:

a) List the assets and liabilities on the balance sheet for the banking system. Can banks make any loans? Explain.

b) The Fed makes an open market purchase of $500 of government securities from the banks. List the items on the banking system's balance sheet before any lending takes place.

c) List the items on the banking system's balance sheet after full monetary expansion has taken place (assume the expansion takes place by the banks making loans rather than purchasing securities).

d) If the economy is in recession when this easy money policy takes place, explain how the policy works and what effects it will have on real GDP, employment, and the price level (assume that the size of the open market operation is large enough to affect the economy).

2. If the banking system is currently holding the following: $600 of reserves, $2400 of government securities, $3000 of loans, and $6000 of deposits, and the Reserve Ratio = .10:

a) List the assets and liabilities on the balance sheet for the banking system. Can banks make any loans?

b) The Fed makes an open market purchase of $15 of securities from the banks. List the items on the banking system's balance sheet before any lending takes place.

c) List the items on the banking system's balance sheet after full monetary expansion has taken place.