Exercise Set 13
BANKS AND MONEY CREATION

I. Objectives

1. To explain how the Fed effects changes in money supply through the banking system
   

II. Data

The balance sheet of Fultona Bank is shown below.

Assets	Liabilities
Loans: $250m	Checking deposits: $200m
Govt. securities: $100m
Reserves: $20m	Net worth: $170m

Suppose the required reserve ratio is 10%.

Assume that the Federal Reserve buys a certain amount of government securities from Fultona. Compute the effect on Fultona's excess reserves. What is the maximum amount of new loans that Fultona can make as a result? And, finally, what is the maximum possible increase in money supply in the economy?

Click on Gimme Creation! to confirm.

III. Questions

1. Select a value for government securities bought by the Fed from Fultona Bank (in millions): $__________

2. Sketch the revised balance sheet showing the effect of the Fed's purchase. Compute Fultona's excess reserves.

3. What is the maximum amount of new loans that Fultona can make? Will Fultona Bank make loans of this amount? Explain.

4. Describe the steps by which money will expand in the economy.
   
   
5. What is the maximum possible increase in money supply (M1)? Show calculations.
   
   
6. Suppose the Fed raises the required reserve ratio to 13%. How will this affect Fultona Bank's (original) balance sheet? Explain exactly why money supply will decrease as a result.

NOTE: In the U.S., banks are no longer required to keep a minimum in reserves: reserve requirement ratio = 0%. [Source: Federal Reserve Board - Reserve Requirements ]