What is money? http://www.youtube.com/watch?v=DjTs-rjVkB8&feature=relmfu Creating money http://www.youtube.com/watch?v=pZRvja7Mvrw&feature=relmfu The Fed http://www.youtube.com/watch?v=aMg3vrQ6keE&feature=relmfu

1. True, False, or Uncertain: “When a commercial bank makes loans, it creates money; when loans are repaid, money is destroyed.” Explain. 2. Citizen's Bank has reserves of $20,000 and demand deposits of $100,000. The reserve ratio is 20 percent. Households deposit $5,000 in currency into the bank which is added to reserves. How much excess reserves does the bank now have? 3. Suppose again that Citizen's Bank has reserves of $20,000 and demand deposits of $100,000. The reserve ratio is 20 percent. The bank now sells $5,000 in securities to the Federal Reserve Bank in its district, receiving a $5,000 increase in reserves in return. What level of excess reserves does the bank now have? Compare your answer to the answer from question 2.

1. True, False, or Uncertain: “When a commercial bank makes loans, it creates money; when loans are repaid, money is destroyed.” Explain.

2. Citizen's Bank has reserves of $20,000 and demand deposits of $100,000. The reserve ratio is 20 percent. Households deposit $5,000 in currency into the bank which is added to reserves. How much excess reserves does the bank now have?

3. Suppose again that Citizen's Bank has reserves of $20,000 and demand deposits of $100,000. The reserve ratio is 20 percent. The bank now sells $5,000 in securities to the Federal Reserve Bank in its district, receiving a $5,000 increase in reserves in return. What level of excess reserves does the bank now have? Compare your answer to the answer from question 2.

14‑4 (Key Question) “When a commercial bank makes loans, it creates money; when loans are repaid, money is destroyed.” Explain. Remember the definition of M1: When a bank makes a loan, it increases M1 (money is “created”). When people pay off loans; the money supply decreases (money is “destroyed”).

Demand deposits have risen to $105,000. 14‑9 The Citizen's Bank has reserves of $20,000 and demand deposits of $100,000. The reserve ratio is 20 percent. Households deposit $5,000 in currency into the bank which is added to reserves. How much excess reserves does the bank now have? Demand deposits have risen to $105,000. Twenty percent of this is $21,000, which is its required reserves. The bank’s actual reserves have risen to $25,000. Therefore, its excess reserves are $4,000 ($25,000 ‑ $21,000). 14‑10 Suppose again that the Citizen's Bank has reserves of $20,000 and demand deposits of $100,000. The reserve ratio is 20 percent. The bank now sells $5,000 in securities to the Federal Reserve Bank in its district, receiving a $5,000 increase in reserves in return. What level of excess reserves does the bank now have? Why does your answer differ from the answer to question 9? The bank now has excess reserves of $5,000 (rather than $4,000). Reserves are against liabilities (i.e. the demand deposits) – amounts that the bank must pay back to its owners. In this case, the level of demand deposits did not change; neither did the req’d reserves. In the former case, $1,000 of new cash reserves were needed against the $5,000 increase in demand deposits.

14‑11 Suppose a bank discovers its reserves will temporarily fall slightly short of those legally required. How might it remedy this situation through the Federal funds market? Next, assume the bank finds that its reserves will be substantially and permanently deficient. What remedy is available to this bank? (Hint: Recall your answer to question 4.) Banks can borrow temporarily from other banks that have excess reserves. These funds are transferred from one bank’s reserve account to the other and allow the lending bank to earn interest on otherwise idle excess reserve funds (while replenishing the reserves of the deficient bank). If a bank finds that its reserves are substantially deficient, it should suspend lending and gradually build up its reserves as borrowers repay loans made by the bank earlier.

14‑12 Suppose that Bob withdraws $100 of cash from his checking account at Security Bank and uses it to buy a camera from Joe, who deposits the $100 in his checking account in Serenity Bank. Assuming a reserve ratio of 10 percent and no initial excess reserves, determine the extent to which (a) Security Bank must reduce its loans and demand deposits because of the cash withdrawal and… Security Bank will have to reduce its loans and demand deposits by $90, the amount of its new deficiency of reserves. (b) Serenity Bank can safely increase its loans as demand deposits because of the cash deposit. Serenity Bank can safely increase its loans and demand deposits by $90, the amount of its new excess reserves. Have the cash withdrawal and deposit changed the money supply? The money supply has not changed. Bob’s checking account has decreased by $100 and Joe’s checking account has increased by $100.

14‑13 (Key Question) Suppose the simplified consolidated balance sheet shown below is for the commercial banking system. All figures are in billions. The reserve ratio is 25 percent. What amount of excess reserves does the commercial banking system have? Excess reserves = $2 billion; actual reserves of $52 billion minus required reserves of $50 billion. What is the maximum amount the banking system might lend? Maximum lending = $8 billion; excess reserves of $2B and 25% reserve requirement (…$2B/0.25) Show in column 1 how the consolidated balance sheet would look after this amount has been lent. What is the monetary multiplier? Multiplier = 4; m = 1 / R; 1 / 0.25. Answer question 13a assuming that the reserve ratio is 20 percent. Explain the resulting difference in the lending ability of the commercial banking system. Excess reserves = $12 billion; actual reserves of $52 billion minus required reserves of $40 billion. Maximum lending = $60 billion; excess reserves of $12B and 20% req’d reserve (…$12B/0.20). The change in the reserve requirement increases the banks lending potential by $52 billion.