Question

If a bank has total deposits of \(\$ 100,000\) with \(\$ 10,000\) set aside to meet reserve requirements of the Fed, its required reserve ratio is a. \(\$ 10,000\) b. 10 percent. c. 0.1 percent. d. 1 percent.

Short answer

The required reserve ratio of the bank is b. 10 percent.

Step-by-step solution

Understand the required reserve ratio formula

The required reserve ratio formula is given by: \(Required\ Reserve\ Ratio = \frac{Reserve\ Requirements}{Total\ Deposits}\) In this case, Reserve Requirements = \(\$10,000\) and Total Deposits = \(\$100,000\).

Calculate the required reserve ratio

Using the formula, we can now calculate the required reserve ratio: \(Required\ Reserve\ Ratio = \frac{\$10,000}{\$100,000}\)

Simplify the expression

Simplify the numbers in the fraction: \(Required\ Reserve\ Ratio = \frac{10,000}{100,000}\) \(Required\ Reserve\ Ratio = 0.1\)

Express the reserve ratio as a percentage

To express the reserve ratio as a percentage, multiply the fraction by 100: \(Required\ Reserve\ Ratio = 0.1 * 100\) \(Required\ Reserve\ Ratio = 10\%\)

Compare with the options

Now, we can compare our calculated reserve ratio with the options given in the exercise: a. \(\$10,000\) (not a percentage, so it's ruled out) b. 10 percent (matches our calculation) c. 0.1 percent (not correct, it's too small) d. 1 percent (not correct, it's too small) The correct answer is b, which is the required reserve ratio of the bank is 10 percent.

Key concepts

Federal Reserve System

The Federal Reserve System, often simply referred to as "the Fed," is the central banking system of the United States. It was created in 1913 to provide the nation with a safer, more flexible, and stable monetary and financial system. The Fed has several key responsibilities:

• Regulating and supervising financial institutions to ensure safety and soundness.
• Conducting the nation's monetary policy to promote maximum employment, stable prices, and moderate long-term interest rates.
• Maintaining the stability of the financial system and containing systemic risk.
• Providing financial services to depository institutions, the U.S. government, and foreign official institutions.

In the context of the required reserve ratio, the Fed sets the minimum amount that banks must hold in reserve, influencing how much credit the banks can extend to borrowers.
This directly affects the money supply and the economy's overall health.

Banking Reserves

Banking reserves refer to the portion of depositors' balances that banks must have on hand as cash or hold as deposits with the Federal Reserve. These reserves are crucial for ensuring that banks have enough funds to meet customer withdrawals and payments.

• Required reserves: This is the minimal level set by the Fed that banks must hold in reserve. It is determined by the Required Reserve Ratio.
• Excess reserves: Any reserves held beyond the required amount. Banks can lend these out, affecting money creation in the economy.

When a bank receives deposits, it doesn’t keep all of that money available. Instead, it follows the Fed’s reserve ratio, keeping some in reserve and lending the rest. This concept plays a vital role in monetary policy implementation, impacting the amount of money circulating in the economy.

Monetary Policy

Monetary policy refers to the actions undertaken by a nation's central bank, in this case, the Federal Reserve, to manage the money supply and achieve macroeconomic goals that foster economic growth and stability. The primary tools of monetary policy include:

• Open Market Operations: Buying and selling government securities to regulate the money supply.
• Discount Rate: The interest rate charged to commercial banks and other financial institutions for short-term loans from the Federal Reserve Bank.
• Reserve Requirements: The fraction of deposits that banks must hold as reserves. Changes in this ratio can influence how much banks can lend.

By changing reserve requirements, as in the exercise's context, the Fed can influence the amount of money banks can create through lending.
This subsequently impacts interest rates, inflation, and the broader economy. The required reserve ratio is a powerful tool, as small adjustments can significantly affect the money available for borrowing and spending.