Q3. Use commercial bank and Federal ... [FREE SOLUTION] (2024)

Chapter 16: Q3. (page 347)

Use commercial bank and Federal Reserve Bank balance sheets to demonstrate the effect of each of the following transactions on commercial bank reserves:

a. Federal Reserve Banks purchase securities from banks.

b. Commercial banks borrow from Federal Reserve Banks at the discount rate.

c. The Fed reduces the reserve ratio.

d. Commercial banks increase their reserves after the Fed increases the interest rate that it pays on reserves.

Short Answer

Expert verified

a. Balance sheets if Federal Reserve Bank purchase securities

Federal reserves:

Assets	Liabilities and net worth
+Securities	+Reserves of commercial banks
Total (Increase)	Total (Increase)

Commercial banks:

Assets

Liabilities

-Securities

+Reserves

Total

b. Balance sheets if a commercial bank borrows from Fed

Federal reserves:

Assets	Liabilities and net worth
+Loans to commercial banks	+Reserves of commercial banks
Total	Total

Commercial bank:

Assets	Liabilities
+Reserves
Total	Total

c. Balance sheets after reducing the reserve ratio

Federal reserve:

Assets	Liabilities and net worth
	-Reserves of commercial banks
Total	Total

Commercial bank:

Assets	Liabilities
+loans
Total	Total

d. Balance sheets after Fed increases the interest rate on reserves.

Federal reserve:

Assets	Liabilities and net worth
	+Reserves of commercial banks
Total	Total

Commercial bank:

Assets	Liabilities
+Reserves
Total	Total

Step by step solution

Step 1. Explanation for part (a)

When federal reserve purchases securities from the commercial bank, they are added to the asset side of the Fed's balance sheet and are reduced from the asset side in the balance sheet of the commercial banks.

The reserves of the commercial banks are increased since the Fed makes payments for buying these securities. This adds to the liability of the Federal Reserve and assets of the commercial banks.

Step 2. Explanation for part (b)

When commercial banks borrow from the Fed, the assets side of the federal reserve's balance sheet increases since the loans to commercial banks are assets for federal reserves as they will be paid back. Since the loans are borrowed at a discounted rate, the reserves of the commercial banks are increased.

Step 3. Explanation for part (c)

As the Fed reduces the reserve ratio, the amount which a bank needs to hold to support the withdrawals also gets reduced. The bank enhances the money supply by offering loans from this. Loans are considered to be an asset, and this will be reflected in the asset side of a commercial bank. Fed keeps these reserves with them as collateral of loans. Thus, they are shown on their balance sheet's liabilities and net worth side. Thus, since reserves have increased, it will also reflect in the Fed's balance sheet.

Step 4. Explanation for part (d)

Since commercial banks have increased their reserves due to increased interest rates offered by Fed on reserves rates, the reserves column on the assets side of commercial banks will increase. In contrast, commercial banks' reserve on the liabilities and net worth side of the Fed's balance sheet will also increase.

Most popular questions from this chapter

In 1980, the U.S. inflation rate was 13.5 percent, and the unemployment rate reached 7.8 percent. Suppose that the target rate of inflation was 3 percent back then and the full employment rate of unemployment was 6 percent at that time. What value does the Taylor Rule predict for the Fed’s target interest rate? Would you be surprised to learn that the Fed’s targeted interest rate (the federal funds rate) reached 18.9 percent in December 1980?When bond prices go up, interest rates go _______.a. upb. downc. nowhereWhich of the following Fed actions will increase bank lending?Select one or moreanswers from the choices shown.a. The Fed raises the discount rate from 5 percent to 6 percent.b. The Fed raises the reserve ratio from 10 percent to 11 percent.c. The Fed lowers the discount rate from 4 percent to 2 percent.d. The Fed sells bonds to commercial banks.Refer to the table for Moola below to answer the following questions. What is the equilibrium interest rate in Moola? What is the level of investment at the equilibrium interest rate? Is there either a recessionary output gap (negative GDP gap) or an inflationary output gap (positive GDP gap) at the equilibrium interest rate, and, if either, what is the amount? Given money demand, by how much would the Moola central bank need to change the money supply to close the output gap? What is the expenditure multiplier in Moola?Money Supply ($)Money Demand ($)Interest Rate (%)Investment at Interest Rate Shown ($)Potential Real GDP ($)Actual Real GDP at Interest(Rate Shown) ($)500500500500500800700600500400234565040302010350350350350350390370350330310 Suppose that actual inflation is 3 percentage points, the Fed’s inflation target is 2 percentage points, and unemployment is 1 percent below the Fed’s unemployment target. According to the Taylor rule, what value will the Fed want to set for its targeted interest rate?

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