Question

17. For the following operations, what happens to the central bank's and commercial bank's reserves and the monetary base? Use T-account to show changes in balances. Assume that the amount is $\$10$million.

a. The central bank provides loan to commercial bank.

b. The central bank sells securities to the commercial bank.

c. The commercial bank repays the loan to the central bank.

Short answer

a. T-account balance is

b. T-account balance is

c. The currency in circulation fell by $\$10$million, while reserves remained unchanged. As a result, the Monetary Base fell $\$10$million.

Step-by-step solution

Introduction 

A central bank is an apex monetary authority that controls the money supply and formulates monetary policy. A commercial bank is a financial institution that accepts deposits and extends loans.

Explanation 

a. If a central bank provides a loan to a commercial bank, the loan amount would be a liability for the commercial bank while it would be an asset for the central bank.

	Central bank
Assets	Liabilities
Loan $10 million	Reserves $10 million

	Commercial bank
Assets	Liabilities
Reserves $10 million	Loans $10 million

b. If the central bank sells securities to the commercial bank, the currency it receives in exchange would be added to its liabilities while it would an asset for the central bank.

	Central bank
Assets	Liabilities
Securities $10 million	Currency $10 million

	Commercial bank
Assets	Liabilities
Currency $10 million
Securities $10 million

c. If the commercial bank repays the loan to the central bank the loan amount would be removed from its liabilities.

	Central bank
Assets	Liabilities
	Reserves $10 million

	Commercial bank
Assets	Liabilities
Reserves $10 million	Loans $10 million
Reserves $0 million	Loans $0 million