Wahoo Bank Balance Sheet & Its Monetary Policy Effects

Assets

The effect of money is considerable on the lives of all individuals. The individuals earning more money could consume more goods and services, which increase their standard of living. Money is termed as currency as well and it performs three main functions in an economy, which are described as follows:

Medium of exchange or payment:

When individuals are working in organizations, they often expect to receive their payments in currency, which could be spent readily on stuffs like clothing, food and other products and services (Godley & Lavoie, 2016). Thus, money serves as a way of exchanging products and services across an economy and it does not rely on barter system. Thus, goods and services could be purchased and sold easily. For example, it might be troublesome for an individual to purchase the needed stuffs, if the payment is made in the form of products that the organization produces, instead of money.

Unit of account:

Money helps in providing a meaningful measure of the value of a product or service and a technique of recording and reconciling financial transactions. When numbers are placed on the values of the products and services, comparison could be made easily (Aruoba, Davis & Wright, 2016). As a result, the individuals not having adequate knowledge about a particular product or service could measure the expensiveness of the product.

Store of value:

When money is earned, it is not necessary to use the same immediately. Money could be saved and it could be exchanged for products and service at a later point of time. As the value of money is retained, it helps in gauging wealth (Johnson, 2017). An individual increases the wealth with rise in savings. It is necessary to maintain the value of money over time to increase its effectiveness. In case, any currency faces rapid recession, money might not serve as effective store of value. As a result, the individuals might be compelled to exchange money for other global currencies or stores of value like valuable metals.

Out of these stated functions, the most significant is the medium of exchange or payment. This function defines the characteristic of money. Money is accepted primarily as a medium of exchange and hence, it could be used for making and receiving payments for the products and services purchased and sold.

The federal funds rate and discount rate are two techniques, which the Federal Reserve utilizes in setting the monetary policy of the US. In this context, Pierce & Tysome (2014) advocated that the federal funds rate is the rate of interest, which the depository institutions charge each other in case of overnight loans. The depository institutions in US mainly comprise of savings and loans, banks and credit unions. On the other hand, the discount rate could be defined as the rate of interest, which the Federal Reserve Bank charges at the time of making collateral loans. These loans are passed overnight usually to the depository institutions. Hence, it could be said that both the rates are utilized in controlling monetary policy; however, they tend to vary in nature (Bakir, 2015).  

Liabilities

Part a:

In the above case, the balance of the checking accounts would be reduced by $500. As a result, the adjusted checking balance account would stand at $3,500 ($4,000 – $500). This would result in minimization of the overall liability balance by $500. Hence, the value of the total liabilities would be $4,500 ($5,000 – $500). There would be reduction in the required reserve amount by $50 ($500 x 10%). As a result, the balance of the required reserves after adjustment stands at $350. An amount of $450 is deducted from the loan balance, which stands at $2,550. Hence, the value of the total assets stands at $4,500, which is reduced by $500 as well (Allen et al., 2017).

Part b:

In this case, an amount of $1,000 is deducted from the government securities and the same amount is added with loans. As a result, the values of government securities and loans are obtained as $600 and $4,000 respectively. There would be no effect on the liability side of the bank (Beck et al., 2017).

Part a:

Part b:

It has been observed from the above two tables that the increase in money supply would be greater in the second situation in contrast to the first situation. This is because in the second situation, the securities are purchased directly from the bank. As a result, it eliminates the need of the bank in holding any needed reserves (Werner, 2016). Hence, the overall amount of $1,000 is expected to grow, while in the first situation, required reserve is mandatory. As a result, the rise in money supply in the first situation is lower compared to the money supply increase in the second situation.

References:

Allen, F., Armour, J., Balling, M., Belchambers, A., Danielsson, J., Gnan, E., … & Micheler, E. (2017). Central banking and monetary policy: Which will be the post-crisis new normal?. SUERF Studies.

Aruoba, S. B., Davis, M. A., & Wright, R. (2016). Homework in monetary economics: Inflation, home production, and the production of homes. Review of Economic Dynamics, 21, 105-124.

Bakir, C. (2015). Fragile by design: The political origins of banking crises and scarce credit. Public Administration, 93(3), 828-830.

Beck, T., Degryse, H., De Haas, R. & Van Horen, N. (2017). When arm’s length is too far. Relationship banking over the business cycle. Finance and Insurance.

Godley, W., & Lavoie, M. (2016). Monetary economics: an integrated approach to credit, money, income, production and wealth. Springer.

Johnson, H. G. (2017). Major Issue in Monetary Economics. In Macroeconomics and Monetary Theory (pp. 55-58). Routledge.

Pierce, D. G., & Tysome, P. J. (2014). Monetary economics: theories, evidence and policy. Butterworth-Heinemann.

Werner, R. A. (2016). A lost century in economics: Three theories of banking and the conclusive evidence. International Review of Financial Analysis, 46, 361-379.