Explore BrainMass

Discount Rate in the Banking System

This content was STOLEN from BrainMass.com - View the original, and get the already-completed solution here!

(a) Third National Bank is fully loaned up with reserves of $20,000 and demand deposits equal to $100,000. The reserve ratio is 20%. Households deposit $5,000 in currency into the bank. How much excess reserves does the bank now have, and what is the maximum amount of new money that can be created in the banking system as a result of this deposit? Show all work.

(b) What is the discount rate in the banking system, and explain how the Fed manipulates this rate in order to achieve macroeconomic objectives.

© BrainMass Inc. brainmass.com October 25, 2018, 3:40 am ad1c9bdddf

Solution Preview

a. The bank has initial deposits of $100000, and the required reserve ratio is 20%. So the bank has to keep 20% of $100000 = $20000 in reserves. When households deposit an additional $5000, the demand deposits of the bank rise to $105000, and the bank is now required to keep 20% of $105000 = $21000 in reserves. It already has $20000, so the bank will need to add another $1000 to reserves and can loan another $4000 (= $5000 - $1000).

In the absence of currency drain the money multiplier is given by 1/RRR, where RRR stands for the required reserve ratio. Here it is 20%, or 0.2, and hence the money multiplier is 1/0.2 = 5. Thus a deposit of $5000 ...

Solution Summary

Calculations are shown for solving the increase in monetary supply due to new demand deposits. An explanation for why how these calculations are determined and what happens to the money supply is provided along with a discussion of the Federal Reserves manipulation of interest rates with regards to monetary policy. This solution is 455 words.

See Also This Related BrainMass Solution

Federal Reserve: Reasons for bank regulations, effect of policies

Assignment Overview

In the individual assignment due this week, students explore the reasons behind regulating banks and how that regulation relates to the formation of the Federal Reserve System. Students demonstrate an understanding of the effects Federal Reserve policies have on interest rates, financial markets, and financial institutions. Students are given the opportunity to participate in additional activities that further explore the risks faced by financial institutions and how those risks are measured.

In the Learning Team assignment due this week, students deepen their understanding of the services provided, main source of funding, interactions with financial markets, and how Federal Reserve policies affect financial institutions.

View Full Posting Details