What is the effect on (1) demand deposits, (2) required reserves, and (3) excess reserves of banks given the following transactions? a. The general public transfers funds from savings accounts checking accounts. b. Corporations borrow from commercial banks. c. State and local governments issue debt securities that are purchased by commercial banks. d. Homeowners borrow from commercial banks to finance home improvements. (Are there any differences on the expansion of the money supply in questions (b), (c), and (d)?) e. A bank in California with excess reserves lends these funds through the federal funds market to a bank in Maine that has insufficient reserves. f. Corporations issue short?term securities that are purchased by the general public. g. Corporations retire (i.e., pay off)

Question

loans from commercial banks. h. The Federal Reserve buys Treasury bills that are sold by the general public. i. The Federal Reserve raises the discount rate, and banks retire debt owed the Federal Reserve. j. The Federal Reserve raises the reserve requirement on demand deposits. k. The Treasury borrows from the banks to finance payments. l. The federal government runs a deficit and borrows the funds from the general public. m. The federal government runs a deficit and borrows the funds from the Federal Reserve.

What will be an ideal response?

Answer 1

 a. Demand deposits ? increase  Required reserves ? increase  Excess reserves ? decrease?b. Demand deposits ? increase  Required reserves ? increase  Excess reserves ? decrease?c. Demand deposits ? increase  Required reserves ? increase  Excess reserves ? decrease?d. Demand deposits ? increase  Required reserves ? increase  Excess reserves ? decrease?These three questions (b, c, and d) illustrate that from the viewpoint of the banking system, it does not matter if the banks acquire debt issued by firms, governments, or households. To acquire the debt, the banks must have excess reserves. After they have used their excess reserves, the money supply is expanded, and the excess reserves become required reserves.?e. Demand deposits ? no change  Required reserves ? no change  Excess reserves ? no change?Unlike in the previous questions, the lending of excess reserves from one bank to another does not in the aggregate increase or decrease the reserves of the banking system.?f. Demand deposits ? no change  Required reserves ? no change  Excess reserves ? no change?Loans between members of the non?bank general public do not affect banks' reserves and thus do not affect their capacity to lend.?g. Demand deposits ? decrease  Required reserves ? decrease  Excess reserves ? increase?While the creation of new loans uses the banks' excess reserves and creates new money, the retiring of loans from commercial banks reduces demand deposits and restores excess reserves (i.e., increases excess reserves).     ?h. Demand deposits ? increase  Required reserves ? increase  Excess reserves ? increase?i. Demand deposits ? no change  Required reserves ? no change  Excess reserves ? decrease?j. Demand deposits ? no change  Required reserves ? increase  Excess reserves - decrease?Questions i and j illustrate two monetary tools, the reserve requirement and the discount rate. Notice that changing the discount rate and the reserve requirements do not in themselves change demand deposits. Their impact is on reserves, and the effect of this impact may lead to a change in the supply of money.?k. Demand deposits ? increase  Required reserves ? increase  Excess reserves ? decrease?l. Demand deposits ? no change  Required reserves ? no change  Excess reserves ? no change?m. Demand deposits ? increase  Required reserves ? increase  Excess reserves ? increase?During a period of inflation, a policy that contracts the money supply and the capacity of banks to lend is desirable. The opposite situation would apply during a recession. If there were a deficit during a period of recession, it is desirable to increase the money supply and the capacity of the banks to lend. Hence n is better than m.