Question

Please write unique anwers.

1. What is the reserve ratio? What is the relationship between the reserve ratio and the money multiplier?

2. What is the equation of exchange? What are the variables, which are in it, and how do they relate to each other?

Answer 1

1.

Bank can’t use the entire deposit amount for lending purpose but a portion of it must keep in hand for security reason, which is known as reserve ratio. This is compulsory as per the regulation of country’s central bank.

Relationship: There is inverse relationship between these two. The increasing reserve ratio decreases money multiplier, and vice versa.

Example: If the reserve ratio is 10%; Money multiplier = (1 / Reserve ratio) = (1 / 0.10) = 10

                If the reserve ratio is 20%; Money multiplier = (1 / Reserve ratio) = (1 / 0.20) = 5