Question

Other things being equal, if the reserve ratio is raised from 10 percent to 25 percent

A.maximum potential value of the money multiplier falls from 10 to 4.

B.maximum potential value of the money multiplier rises from 10 to 25.

C.minimum potential value of the money multiplier rises from 0.10 to 0.25.

D.minimum potential value of the money multiplier falls from 10 to 5.

Answer 1

Formula :

Multiplier = (1 + c)/(e + c + r) where c = currency to deposit ratio, e = excess reserve ratio and r = required reserve ratio.

Potential multiplier will be maximum when c = currency to deposit ratio = 0 and e = excess reserve ratio = 0(This means that when public hold to nucurrency and Banks hold no excess reserves)

So, Maximum potential multiplier = (1 + 0)/(0 + 0 + r) = 1/r

Now when r = required reserve ratio = 10% = 0.10 => Maximum potential multiplier = 1/0.1 = 10.

Also, when r = required reserve ratio = 25% = 0.25 => Maximum potential multiplier = 1/0.25 = 4

Thus, if the reserve ratio is raised from 10 percent to 25 percent then maximum potential multiplier will fall from 10 to 4.

Hence, the correct answer is (A) maximum potential value of the money multiplier falls from 10 to 4.