The Federal Reserve purchases $8 million in U. S. Treasury bonds from a bond dealer, and the dealer's bank credits the dealer's account. The required reserve ratio is 19 percent, and the bank typically lends any excess reserves immediately. Assuming that no currency leakage occurs, calculate how much will the bank be able to lend to its customers following the Feds purchase $million.

The amount that the bank will be able to lend to its customers following the Feds purchase is $6,480,000.

The reserves is the amount of deposits that the Federal Reserve requires banks to hold with them and not lend. The level of Banks Reserves and deposit liabilities determine the amount a bank can lend out.

Given Information

Bond value = $8,000,000

Required reserve ratio  = 19%

Amount it will be able to lend = $8,000,000 * (1 - 19%)

Amount it will be able to lend = $8,000,000 * (1 - 0.19)

Amount it will be able to lend = $8,000,000 * 0.81

Amount it will be able to lend = $6,480,000

Therefore, the amount that the bank will be able to lend to its customers following the Feds purchase is $6,480,000.

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The bank will be able to lend:

$42,105,263 ($8 million/ 0.19)

Explanation:

The above amount which the bank can lend from the $8 million received from the Federal Reserve for a customer is a function of $8 million deposit in a customer's account and the reserve ratio.  This is called the money multiplier.

The money multiplier is the amount of money that banks generate with each dollar of reserves. Reserves is the amount of deposits that the Federal Reserve requires banks to hold and not lend.  The level of Reserves and deposit liabilities determine the amount a bank can lend out.

The process by which banks create more money than the physical money is called money creation.  This shows that a bank creates more money in the economy through its lending activities.

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