(Table: Central Bank Balance Sheet) Using the balance sheet provided, if the central bank issues 100 million more in foreign debt, then:
A) the backing ratio would be equal to 95%.
B) the backing ratio would be equal to 105%.
C) there is no change in the backing ratio.
D) the backing ratio would decrease to 50%.

Question

(Table: Central Bank Balance Sheet) Using the balance sheet provided, if the central bank issues 100 million more in foreign debt, then: 
A) the backing ratio would be equal to 95%. 
B) the backing ratio would be equal to 105%. 
C) there is no change in the backing ratio. 
D) the backing ratio would decrease to 50%.

Quizplus · Accepted Answer

The backing ratio is calculated as the ratio of high-powered money to total liabilities. If the central bank issues 100 million more in foreign debt, its liabilities increase by 100 million, while high-powered money stays the same. Therefore, the ratio of high-powered money to total liabilities decreases, and the backing ratio decreases. If we do the calculations, we get:
High-powered money = 1,000
Liabilities = 1,000 + 600 + 100 = 1,700
Backing ratio = 1,000 / 1,700 = 58.82%
If the central bank issues 100 million more in foreign debt, the liabilities increase to 1,800, so the backing ratio becomes:
Backing ratio = 1,000 / 1,800 = 55.56%
Therefore, the backing ratio would decrease to 55.56%, which is less than 100%, indicating that the central bank's liabilities are not fully backed by high-powered money. However, it is still above the minimum required ratio of 50%.

(Table: Central Bank Balance Sheet) Using the Balance Sheet Provided