If the Fed lends five banks an additional total of 100...

If the Fed lends five banks an additional total of $\$ 100$ million but depositors withdraw $\$ 50$ million and hold it as currency, what happens to reserves and the monetary base? Use T-accounts to explain your answer.

Key Concepts

Central Bank Operations

Central bank operations, such as lending to commercial banks, involve adjustments to the amount of reserves in the banking system. When the central bank lends money, it increases bank reserves; however, actions like depositor withdrawals convert a portion of these reserves into currency. While such withdrawals shift the composition between reserves and currency, they do not necessarily change the overall monetary base.

Monetary Base

The monetary base, also known as high-powered money, is the sum of currency in circulation and bank reserves held at the central bank. It represents the foundational layer of money that supports further expansion of the money supply through the banking system. Any change in reserves or currency directly impacts the monetary base.

T-Accounts

T-accounts are a tool used in accounting and balance sheet analysis to visually display the debit and credit sides of a financial transaction. They help in tracking changes in assets and liabilities, making it easier to understand how an operation, such as a central bank’s lending or deposit withdrawal, impacts different parts of a balance sheet.

Bank Reserves

Bank reserves are the deposits that commercial banks hold either in their vaults or at the central bank. These reserves are used to settle interbank transactions and to meet regulatory requirements. Changes in bank reserves, whether through direct lending by the central bank or through withdrawals by depositors, reflect important shifts in the liquidity available to banks.

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