Q. Assume that the Bank of Ecoville has the following balance sheet and the Fed has a 10% reserve requirement in place: BALANCE SHEET FOR ECOVILLE INTERNATIONAL BANK ASSETS LIABILITIES Cash $33,000 Demand deposits $99,000 Loans $66,000 Now assume that the Fed lowers the reserve requirement to 8%. 1. What is the maximum amount of new loans that this bank can make? 2. Assume that the bank makes these loans. What will the new balance sheet look like? 3. By how much has the money supply increased or decreased?

Answer:Reserve requirement = 10% presently

1) Now fed has lowered the reserve requirement to 8%i.e. Bank has to keep reserve of 8% and loan 92% of the deposit.Thus , now bank can loan 92% of $99,000 = $90,720Bank has already loaned $66,000So, new loan bank can make = $90,720 - $66,000 = $24,720

2) New balance sheet will look like:

Asset LiabilitiesCash $8,280 Demand Deposit $99,000Loans $90,720

3) New loan made = $24,720, Reserve ratio = 8%Due to money multiplier effect, increase in money supply = (1/0.8) * $24,720

= $309,000