Suppose that the Federal Reserve makes a 10 million...

Suppose that the Federal Reserve makes a $\$ 10$ million discount loan to First National Bank (FNB) by increasing FNB's account at the Fed. a. Use a T-account to show the effect of this transaction on FNB's balance sheet. Remember that the funds a bank has on deposit at the Fed count as part of its reserves. b. Assume that before receiving the discount loan, FNB has no excess reserves. What is the maximum amount of this $\$ 10$ million that FNB can lend out? c. What is the maximum total increase in the money supply that can result from the Fed's discount loan? Assume that the required reserve ratio is 10 percent.

Suppose that the Federal Reserve makes a $\$ 10$ million discount loan to First National Bank (FNB) by increasing FNB's account at the Fed.
a. Use a T-account to show the effect of this transaction on FNB's balance sheet. Remember that the funds a bank has on deposit at the Fed count as part of its reserves.
b. Assume that before receiving the discount loan, FNB has no excess reserves. What is the maximum amount of this $\$ 10$ million that FNB can lend out?
c. What is the maximum total increase in the money supply that can result from the Fed's discount loan? Assume that the required reserve ratio is 10 percent.

Key Concepts

T-Account

A T-account is a simple graphical representation of a ledger account that uses two columns to record debits on one side and credits on the other. It helps visualize the effects of individual transactions on different aspects of a financial statement, such as a bank's balance sheet.

Bank Balance Sheet

A bank’s balance sheet is a financial statement that lists its assets, liabilities, and equity. Assets include loans and reserve balances, while liabilities include deposits and borrowed funds. The balance sheet changes as a result of transactions like receiving a discount loan or making new loans.

Discount Loan

A discount loan is a short-term loan provided by a central bank to commercial banks, typically through its discount window. When a bank receives a discount loan, it increases its reserves, enhancing its capacity to lend, but it also assumes a liability that must be repaid.

Excess Reserves

Excess reserves refer to the funds that a bank holds beyond the minimum required by regulatory bodies. These funds can be used to make additional loans, thereby potentially increasing the money supply if they are lent out to businesses or consumers.

Required Reserve Ratio

The required reserve ratio is a regulatory mandate that determines the minimum fraction of customer deposits that banks must hold as reserves. This ratio affects how much a bank can lend, as only the funds above the required reserve amount (excess reserves) may be used for lending.

Money Multiplier

The money multiplier is the factor by which an open market operation or a similar action can theoretically increase the total money supply. It is derived from the inverse of the required reserve ratio, and represents the potential expansion in the money supply from a given increase in bank reserves.

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