The Treasury usually requires most businesses to regularly deposit taxes withheld from employees into accounts at designated commercial banks. On a regular basis, the funds in these accounts are transferred to the Treasury's account at the Fed. Discuss what is happening to the balance sheet of the banking system as the businesses are making deposits and these tax accounts are increasing. What happens to the banking system's balance sheet when the funds are transferred to the Fed?
What will be an ideal response?
As the deposits are made by businesses the liabilities of the banking system are increased since these deposits are assets for the Treasury and liabilities of the banks. The asset side of the balance sheet is also increasing as these funds are adding to reserves. Once the funds are transferred to the Fed the liabilities are decreased by the amount of the transfer but also assets are decreased as the reserve account of the appropriate banks will be debited by the Fed.
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