Question

If the required reserve ratio (RRR) in U.S. is 10 percent and you deposit $5,000, which is wired from your parents’ bank account in Germany to your checking account in the U.S. National Bank, then the change in the U.S. money supply eventually should be

      
no change.

       
a $5,000 increase.

       
a $45,000 increase.

       
a $50,000 increase.

Answer 1

Answer

Option c) is correct. $45000 increase.

Reason:

The money multiplier formula = 1 / Reserve Requirement

The money multiplier is then multiplied by the change in excess reserves to determine the total amount of M1 money supply created in the banking system.

Step 1. Given the reserve requirement is 10% (or 0.10), the money multiplier = 1/ 0.10 = 10

Step 2. We have identified that the excess reserves are $4500 ($5000 - $500), so, using the formula we can determine the total change in the M1 money supply:

Total change in the M1 Money Supply= Money Multiplier * Excess Reserves

= 10 * $4500

= $45000

Step 3. Thus, we can say that, in this example, the total quantity of money generated in this economy after all rounds of lending are completed will be $ 45000