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Money and Banking

Dubya decides to deposit $5,000 of his cash holdings in Wachovia. The required reserve ratio is set at 10 percent or .10 and the bank does not hold any excess reserves.

a. What is the immediate effect on his deposit on the banking system? Explain.

b. What is the maximum amount of money that Wachovia could loan out? Explain how you determined this amount.

c. What is the maximum of money that the entire banking system can create? Explain how you determined this amount. Show your work.

d. Given one reason why the money supply may not increase in the amount that you have identified in part c.

2. Define the following terms and explain their importance to the study of macroeconomics:

a.
money

b.
M1

c.
Equation of Exchange

d.
Money multiplier

3. How does an open market purchase by the Fed affect the level of bank reserves and the interest rate? That is the FED decided to increase the money supply. Illustrate the interest rate effect by drawing the money market graph. What happens to the quantity of money?

Solution Preview

Please find my response attached in the word document.

1. Dubya decides to deposit $5,000 of his cash holdings in Wachovia. The required reserve ratio is set at 10 percent or .10 and the bank does not hold any excess reserves.
a. What is the immediate effect on his deposit on the banking system? Explain.
Answer: As soon as a deposit is made, the bank's liability increases by 5,000 and its reserves increase by 5,000 as well.
b. What is the maximum amount of money that Wachovia could loan out? Explain how you determined this amount.
Answer: The maximum amount Wachovia could loan out is 90% of 5,000, which is 4,500. It is supposed to keep 10% of its liability in reserves.
c. What is the maximum of money that the entire banking system can create? Explain how you determined this amount. Show your work.
Answer: The maximum money the ...

Solution Summary

The solution explains several concepts related to money and banking such as the required reserve ration, M1, Equation of Exchange etc.

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