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Assume that the Bank of Ecoville has the following balance sheet and the Fed has a 10% reserve requirement in place:

BALANCE SHEET FOR ECOVILLE INTERNATIONAL BANK
ASSETS LIABILITIES
Cash $33,000 Demand deposits $99,000
Loans $66,000

Now assume that the Fed lowers the reserve requirement to 8%.

What is the maximum amount of new loans that this bank can make?

Assume that the bank makes these loans. What will the new balance sheet look like?
By how much has the money supply increased or decreased?
Explain your answers.

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Solution Summary

Changes in Monetary Policies are assessed.

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First, we begin with the definition of the reserve requirement. A reserve requirement is the percentage of a banks total liabilities it must keep in cash. Thus, this particular bank has 1/3 of its demand deposits in reserve, well above the 10% requirement. If the Fed lowers the reserve requirement to 8%, the bank could potentially loan 92% of its demand deposits or 91080. Then, the amount of ...

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