Question

The Federal Reserve has set the reserve requirement at 20% (assume all banks satisfy this condition). If you decide to take $600 from your piggy bank and deposit it into your personal banking institution, what is the maximum amount money supply would change?

Answer 1

As Reserve requirement = 20% of deposits

Required Reserves = 20% of $600 = 0.2*$600 = $120

So, Excess reserves = $600 - $120 = $480

Now,

We know Money Multiplier = 1/(Reserve Requirement Ratio) = 1/20% = 1/0.2 = 5

As the excess reserves can be loaned out so the money multiplier will work on excess reserves.

As, Change in money supply = Money multiplier * Excess Reserves

= 5 * $480

= $2400

• Hence, The maximum amount the money supply would change is increase by $2400