Unit 7 Bu204 Page 1 Of 4: Unit 7 Assignment Money, Banks, An

Unit 7 Bu204page 1 Of 4unit 7 Assignment Money Banks And The Fed

This assignment deals with money, the Federal Reserve System, and the effects of money growth on the rate of inflation. In this assignment, assume you are hired as an assistant quantitative analyst at a bank, and one of your duties is calculating reserves and loans based on total deposits in the bank. Given the scenarios provided below, complete the tables and explain the computation results. The assignment includes a combination of short paragraph answers, computations, and a word essay.

First, analyze how the money supply increases in two scenarios involving changes in deposits and currency holdings, and compute the resulting total money supply and the money multiplier. Then, you will be asked to explain how specific actions by the Federal Reserve—such as purchasing bonds, auctioning credit, raising the discount rate, or increasing reserve requirements—impact the money supply. Additionally, you'll evaluate a bank's balance sheet based on given data, analyze the effects of changing reserve requirements, and compute how the money supply is affected. Finally, you are asked to provide recommendations based on these results, including the bank’s response to changes in monetary policy, and discuss the implications for loan rates and reserve strategies.

Paper For Above instruction

The analysis of the impact of the money supply, banking reserves, and Federal Reserve policies reveals critical insights into how macroeconomic tools influence economic activity. As a future assistant quantitative analyst, understanding these mechanisms is essential for maintaining financial stability and guiding strategic decisions within banking institutions.

Analysis of Money Supply Increase Scenarios

In the first scenario, where public holdings of currency and the reserve ratio are considered, a deposit of $500 triggers a sequence of reserve requirements and lending activities. With 50% of currency held by the public and a reserve ratio of 20%, the initial reserve requirement at the bank amounts to $100 (20% of $500), leaving $400 of excess reserves available for lending. Since the public chooses to hold 50% of the loan proceeds as currency, only $200 of the loan generated from the initial deposit is deposited back into the banking system. This recursive process continues until the excess reserves are exhausted, and the total increase in the money supply is the sum of the original deposit and all subsequent deposits created through the lending process.

Calculations show that the total money supply increases by a factor influenced by the reserve ratio and the public’s currency holdings. In contrast, in the second scenario where none of the loan proceeds are held as currency by the public, the entire amount of the loans accelerates deposit creation, resulting in a more substantial increase in the money supply. The differences highlight how the public’s preference for cash holdings dampens the transmission of monetary policy through the banking system into the broader economy.

Money Multiplier and Its Implications

The money multiplier is calculated as the ratio of the total change in the money supply to the initial deposit. In the first scenario, the multiplier is lower due to the currency holdings by the public, which reduces the amount of deposit-led expansion. Conversely, the second scenario yields a higher multiplier, implying that less currency holding and a higher deposit-feeding process amplify the monetary base.

This analysis underscores the inverse relationship between the public’s desire to hold currency and the money multiplier. A higher propensity for holding currency reduces the effective expansion of deposits, limiting the impact of monetary policy actions. Therefore, banking and monetary authorities should consider public currency preferences when implementing policies aimed at influencing the money supply.

Impact of Federal Reserve Actions on Money Supply

The actions taken by the Federal Reserve directly influence the quantity of money in the economy. When the Fed buys bonds, it injects liquidity into the banking system, increasing reserves, and encouraging more lending, thereby expanding the money supply. Conversely, selling bonds withdraws liquidity, reducing reserves and constricting money supply growth. Auctioning credit can have a varying impact depending on the terms and demand, but generally, providing more credit supports expansion.

Raising the discount rate makes borrowing from the Fed more expensive for banks, discouraging reserve accumulation and lending, which contracts the money supply. Conversely, lowering the discount rate encourages borrowing and expands reserves, stimulating growth. Similarly, increasing reserve requirements compels banks to hold more reserves, reducing the funds available for lending and contracting the money supply. Reducing reserve ratios has the opposite effect, promoting lending and expanding the money supply.

Balance Sheet Analysis and Reserve Requirement Changes

Given the bank’s balance sheet with total assets and liabilities, it is essential to verify the structural balance. The assets include required reserves, excess reserves, loans, and Treasury bonds, while liabilities are composed of deposits, which must equal total assets. With $45 million in required reserves, $15 million in excess reserves, $600 million in loans, and $90 million in Treasury bonds, the total assets sum to $750 million, precisely matching the deposits, ensuring the balance sheet balances.

If the reserve requirement increases to 2%, while assuming no change in currency holdings and other assets, the required reserves decrease remarkably relative to the previous ratio. This affects how much banks can lend and thus influence the money supply. Specifically, total reserves decrease, potentially freeing up more funds for lending, provided banks wish to maintain their current excess reserves. The overall effect would be an increase in the money supply due to more available lending capacity.

Strategic Recommendations as a Quantitative Analyst

Based on these computations, strategic recommendations must account for the reserve ratio’s impact on liquidity and lending. When the Federal Reserve raises the reserve ratio, banks should consider increasing interest rates on loans to compensate for the higher reserve requirements or adjusting their lending policies to maintain profitability. Conversely, when the Fed lowers the reserve ratio, banks could capitalize on increased lending opportunities by lowering loan interest rates to attract borrowers and stimulate growth.

When the Fed raises the discount rate, it becomes more expensive for banks to borrow reserves, leading to tightened lending conditions. In such scenarios, banks should tighten their credit standards or diversify funding sources to mitigate funding costs. Conversely, when the Fed lowers the discount rate, expanding credit availability can be achieved by reducing loan rates, fostering economic expansion.

Monitoring and adapting to policy changes requires a flexible strategy, balancing interest rates, reserve requirements, and liquidity management to optimize income while supporting economic stability.

Conclusion

Overall, the insights from these models underline the importance of understanding the relationship between public behavior, Federal Reserve policies, and bank reserve management. Effectively responding to changes in reserve ratios, interest rates, and monetary policy actions allows banks to optimize lending, control liquidity, and contribute to macroeconomic stability. As an assistant quantitative analyst, applying these principles strategic planning enhances the bank’s capacity to adapt to fluctuating economic conditions and supports sustainable growth.

References

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• Federal Reserve Bank of St. Louis. (2020). The Role of the Federal Reserve. Retrieved from https://www.stlouisfed.org
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