ECONOMICS 0115
HOMEWORK #3

1. Use the following data to construct balance sheets for the GFB Bank, the Banking System, and the Federal Reserve Bank. Assume that r = 10%. (Hint: MBR = TR of the Banking System.)

Go-For-Broke Bank  Banking System

DD  =  $100,000                                  DD  =  $10m
NW  =  $20,000                                   NW =  $2m
LL  =  $50,000                                      LL  =  $5m
ER  =  $20,000                                      ER  =  $2m

2. Using the data from Q.1., show how the Go-For-Broke Bank and the Banking System achieve lending equilibrium. How many new DDs are created from new LLs? Explain.

3. Using only the balance sheet for the Banking System from Q.2. when ER = 0, show what happens to the Banking System's balance sheet when the Fed raises the minimum legal reserve ratio to 20%. (Hint: What will the balance sheet look like when ER = 0 again?)

4. Using only the balance sheet for the Banking System from Q.2. when ER = 0, show what happens when the Fed purchases $1m in GS from a bank in the Banking System. (Hint: What will the balance sheet look like when ER = 0 again?)

5. Using only the balance sheet for the Banking System from Q.2. when ER = 0, show what happens when the Fed purchases $1m in GS from a bank in the Banking System and simultaneously raises the minimum legal reserve ratio to 20%.(Hint: What will the balance sheet look like when ER = 0 again?)

6. Assuming that r = 10% and c = 25%, do the following:

                (at Bank i)                                                                (at Bank j)
             Change in ER                                                             Change in ER         Change
                 at Start       Change in     Change in  Change in            at End                    in
Round of Round LL DD  C  of Round M^S

   1            $5.00          $5.00           $4.00          $1.00               $3.60                  $5.00

   2            $3.60

   3

   4

   5

   6

 All
Other
Rounds

Totals

NOTE:

1) Change in LL/(1+c) = Change in DD

2) ER at the end of the round is equal to 9/10 of the DDs. (Why?)

3) Change in M^S = Change in DD +Change in  C. (Why?)

7. Repeat the above example without any cash leakage (c = 0). Compare the two examples. What do you find? Explain.

                (at Bank i)                                        (at Bank j)
             Change in ER                                     Change in ER         Change
                 at Start       Change in     Change in     at End                    in
Round of Round LL DD  of Round M^S

   1            $5.00          $5.00           $5.00         $4.50                  $5.00

   2            $4.50

   3

   4

   5

   6

 All
Other
Rounds

Totals