Please consider a banking system consisting of a central bank and three commercial banks (Bank A, B and C). The balance sheets of the three commercial banks are presented below. Currency in circulation amounts to 500. Besides loans to the banking sector, the central bank only holds securities as assets.
Bank A
| Assets | Liabilities |
| Reserves 25 | Deposits 200 |
| Securities 85 | Borrowings from the central bank 60 |
| Loans 200 |
Bank B
| Assets | Liabilities |
| Reserves 50 | Deposits 400 |
| Securities 200 | Borrowings from the central bank 300 |
| Loans 500 | Borrowings from Bank A 50 |
Bank C
| Assets | Liabilities |
| Reserves 20 | Deposits 160 |
| Securities 130 | Borrowings from the central bank 150 |
| Loans 350 | Borrowings from Bank A and B 100 |
a) Present the balance sheets of the banking system as a whole and the balance sheet of the central bank.
b) Next, determine the size of the monetary base and the size of the money supply (M1).
c) Assume that banks do not hold excess reserves. Use the answers under a) and b) to determine the required reserve ratio (r) and the (maximum) deposit creation multiplier (please round to
two decimals). Also explain why, in practice, the multiplier might be lower.
d) How would the balance sheets of the central bank and the banking system change (present the new balance sheets) after:
1) a sale of 50 of securities by the central bank to the banking sector (disregard the required reserve ratio for this scenario) and
2) (Using the balance sheet you just modified) the central bank setting the required reserve ratio to 0.15, still assuming that banks do not hold excess reserves? Assume the banking system will sell securities to meet this new reserve requirement, and disregard the effect of the money multiplier. What would be the motivation of the central bank to sell securities and what would be the motivation to raise the required reserve ratio?
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