Consider the following situation in the Canadian banking system:
∙ An investment dealer withdraws $10 million from its account at Bank XYZ to
purchase government securities from the Bank of Canada.
∙ As a result,$10 million has been withdrawn from the Canadian banking system.
∙ The target reserve ratio for all banks is 10%.
∙ All commercial banks operate with no excess reserves.
∙ There is no cash drain.
TABLE 26-5
-Refer to Table 26-5.Assume that Bank XYZ has decreased its loans and re-established its target reserve ratio.The second-generation banks in this scenario will

Question

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When the investment dealer withdraws $10 million from its account at Bank XYZ, the bank loses $10 million in reserves. This means that it needs to decrease its loans by $10 million to restore the reserve requirement. However, since all commercial banks operate with no excess reserves, this means that the second-generation banks will also have to adjust their loan positions to maintain their reserve requirements.

Using the money multiplier formula, we can calculate the amount that the second-generation banks will need to decrease their loans by:
Change in loans = (1/reserve ratio - 1) x change in reserves
Change in loans = (1/0.1 - 1) x $10 million
Change in loans = $9.0 million

Therefore, the second-generation banks will need to decrease their loans by $8.1 million to maintain their reserve requirements and restore the overall money supply.

Consider the Following Situation in the Canadian Banking System