Question

Assume the following data describes the condition of the banking system: Total Reserves: $200 billion Transactions Deposits: $800 billion Cash held by public: $400 billion Reserve requirement

Answer 1

To stop further lending activity, the Fed should increase the reserve ratio to 0.25. This makes the total reserves exactly what the required reserve ratio is and stops the bank from lending any further. As the public deposits money into the bank the Fed just needs to keep increasing the required reserve ratio so that the total reserves are equal to the required reserves.

If total transaction deposits = 800 billion and reserve ratio = 0.20 then the required reserves are

800 billion * 0.2 = $160 billion

If the bank holds $200 billion then it can lend 200 - 160 billion = 40 billion.

To stop the bank from lending by increasing the reserve ratio, set the reserve ratio equal to total reserves divided by transaction deposits.

200/800 = 0.25 = new reserve ratio

Answer 2

0.25 is the new ratio and that is the correct answer