Question 1

Zootopia has three commercial banks and a central bank that issues legal tender and issues base money to commercial banks at the policy interest rate of 1%.  Amie has $1,000 in cash that she deposits into her account with the Tiger Bank.  Brad has $2,000 in cash that he deposits into his account with the Dragon Bank, Sam has $1,500 in cash that he deposits into his account with the Bear Bank.   Paula has $500 that she also deposits into her account with the Bear Bank.

a) Show the impact on the balance sheet for the Tiger Bank, Dragon Bank and Bear Bank.  What happens to the amount of base money and broad money in the economy when Amie, Brad, Sam and Paula deposit their cash into their bank accounts? 

b) Amie, Brad and Paula apply for (and receive) loans from their respective banks.  Amie receives $1,500 loan; Brad receives $1,000 loan and Paula receive $2,000 loan.  Show what happens to banks’ balance sheets.  What happens to the amount of base money and broad money in the economy? 

c) Amie employs Brad to do the gardening for her.  She pays Brad $200 by transferring the funds to his account with the Dragon Bank.   Sam hires Paula to do accounting for him for $500 and pays by transferring the funds to her account with the Bear Bank.   Paula buys a second-hand car from Amie for $1,400 and pays by transferring the funds to her account with the Tiger Bank.  Assuming all transactions happen on the same day show the impact on the balance sheet of all the banks. How would the amount of broad money in the economy change as a result of all these transactions? Does any of the banks have a problem?

d) Now assume that in addition to all transactions in c) Paula decides to open an account in the Tiger bank and transfer $1,000 to her new account from her account in the Bear Bank.   Would any of the banks have a problem? Explain using information provided in the question.

e) Are there any ways for a bank to solve a problem with meeting its payment obligations? What determines how much it would cost the bank? Will the amount of base money in the economy change as a result?  Explain. 

f) What would happen if Amie, Brad, Sam and Paula decide to withdraw all their money from their deposits? What is this situation called?