Scenario 1: Fed Buys Bonds from Sheila Jones
Consider a banking system in which the reserve requirement is 10%, banks try not to hold excess reserves, consumers and firms hold money only in the form of checking account balances, and all loan proceeds are spent. Suppose initially all banks in the system are loaned up. Now, suppose that the Fed buys a $100,000 bond from Sheila Jones, who banks at the Perez Bank, and that she deposits her check in her checking account at Perez Bank.
-Refer to Scenario 1. Which of the following happens when Sheila Jones deposits the proceeds from the sale of her bond to the Fed into her checking account at the Perez Bank?
A) Perez Bank's checkable deposits increases by $100,000 and its reserves increases by $90,000.
B) Perez Bank's checkable deposits and reserves increase by $100,000 each.
C) Perez Bank's checkable deposits increases by $90,000 and its reserves increases by $100,000.
D) Perez Bank's checkable deposits and reserves increase by $90,000 each.

Question

Quizplus · Accepted Answer

When Sheila Jones deposits the proceeds from the sale of her bond to the Fed into her checking account at Perez Bank, Perez Bank's reserves increase by $100,000 x 0.1 = $10,000 due to the reserve requirement of 10%. However, since banks try not to hold excess reserves, Perez Bank will lend out the remaining $90,000. As a result, Perez Bank's checkable deposits will also increase by $100,000, since Sheila Jones deposited her check in her checking account at Perez Bank. Therefore, both Perez Bank's checkable deposits and reserves increase by $100,000 each.