Question

# 3. Depending on the type of banking system a nation has, when its commercial bank reserves...

3. Depending on the type of banking system a nation has, when its commercial bank reserves increase by \$1, that nation’s money supply could increase by more than \$1. The rate at which money is created when commercial bank reserves rise is known as the money multiplier. A. Why is the money multiplier is generally greater than 1? In what special case would the money multiplier be equal to 1? B. Suppose the initial money supply is \$1,000 and the commercial bank required reserve-deposit ratio is 0.2. What is the money multiplier in this economy? Explain. C. Find the increase in the money supply associated with increases in bank reserves of \$10, \$50, and \$100. Bank reserves increase by \$10: Bank reserves increase by \$50: Bank reserves increase by \$100:

3.

A.

Money multiplier is generally greater than 1, because most of the economies apply fractional reserves system and in this system, the required reserve ratio is less than 100%.

Further,

Money multiplier = 1/required reserve ratio

So, required reserve ratio is less than 100%, then money multiplier will be greater than 1.

When required reserve ratio is 100%, then money multiplier will be 1.

B.

Money multiplier = 1/RR ratio = 1/.2 = 5

C.

When bank reserve increases by \$10,

Increase in money supply = 10*money multiplier = 10*5 = \$50

When bank reserve increases by \$50,

Increase in money supply = 50*money multiplier = 50*5 = \$250

When bank reserve increases by \$100,

Increase in money supply = 100*money multiplier = 100*5 = \$500

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