Question

1) Assume the Reserve Requirement is 20%. If the bank receives a $100 cash deposit and decides to keep all of it on reserve, then what is the value of the Excess Reserve?

A) $20

B) $60

C) $80

D) $100

2) Use the situation described above, except now assume that the Excess Reserves are loaned out. By how much will the total Money Supply increase?

A) $100

B) $300

C) $400

D) $500

3) If the Fed wants to increase the money supply, it can either:

A) Sell bonds or raise the Reserve Requirement

B) Buy bonds or raise the Reserve Requirement

C) Buy bonds or lower the Reserve Requirement

D) Sell bonds or lower the Reserve Requirement

Answer 1

1. $80

Required reserve = deposit* required reserve ratio

= 100* 20/100

= $20

If whole deposit is kept as a reserve , then excess reserve = 100-20

= $80

2. $400

Multiplier = 1/ reserve requirement

= 1/0.2

= 5

When excess reserve is loaned out, money supply increases by = 80*5 ( through multiplier effect)

= $400

3. Buy bonds or lower the reserve requirement.

When fed purchases bonds, more of money is injected to the economy. When fed lowers the reserve requirement, more of deposits can be loaned out and hence, money supply will increase.