Suppose all banks have zero excess reserves. The Fed buys bonds for $1 million and a bond dealer deposits the check in his or her bank. The required reserve ratio is 10 percent. The bank loans out the maximum it is allowed to a local business. The business writes a check for the full amount for supplies, which is then deposited in another bank. The largest loan the second bank can make is:
The largest loan the second bank can make is $---(Round your answer to the nearest dollar.)
The initial deposit of $1 million by the bond dealer increases the reserves of the bank by $1 million. If the required reserve ratio is 10 percent, this means the bank must hold 10 percent of the reserves, or $100,000, as required reserves.
The remaining reserves, which are excess reserves, can be used to make loans. In this case, the bank loans out the maximum it is allowed to, which is the total reserves minus the required reserves: $1 million - $100,000 = $900,000.
When the local business writes a check for the full amount of $900,000 to pay for supplies, this money is deposited into another bank. However, the second bank has its own required reserve ratio of 10 percent, which means it must hold 10 percent of the deposit as required reserves. Therefore, the largest loan the second bank can make is the deposit minus the required reserves: $900,000 - ($900,000 * 0.1) = $810,000.
Therefore, the largest loan the second bank can make is $810,000.
To calculate the largest loan the second bank can make, we need to determine the initial deposit made by the bond dealer and then apply the required reserve ratio.
Given:
Initial bond purchase by the Fed = $1 million
Required reserve ratio = 10%
Business deposit to the second bank = full loan amount
1. Initial deposit made by the bond dealer:
The bond dealer deposits the check of $1 million in his or her bank.
2. Required reserves:
The required reserve ratio is 10%, so the bank must keep 10% of the initial deposit as required reserves.
Required Reserves = 10% * $1 million = $100,000
3. Excess reserves:
Since all banks have zero excess reserves, the remaining amount after setting aside the required reserves becomes the excess reserves.
Excess Reserves = Initial Deposit - Required Reserves
Excess Reserves = $1 million - $100,000 = $900,000
4. Maximum loan by the second bank:
The second bank can loan out the maximum amount of its excess reserves. So, the largest loan the second bank can make is $900,000.
Therefore, the largest loan the second bank can make is $900,000.