Question

If banks keep one-eighth of their deposits in the form of reserves, and the Fed credits Alex's bank account with $8,000, how much does the money supply increase?

Question 24 options:

a)

$16,000

b)

$1,000

c)

$64,000

d)

$8,000

Because the United States has a fractional reserve banking system, banks hold:

Question 25 options:

a)	no currency in their vaults.

b)	less than 100% of deposits as reserves.

c)	more than 100% of deposits as reserves.

d)	100% of deposits as reserves.

Answer 1

Q24) correct option - c) $64,000

As, credit creation = original deposit * (credit multiplier coefficient)

And

credit multiplier = 1/r , here r is reserve requirement

According to the question,

Original deposit = $8000

r = 1/8

Credit multiplier = 1/(1/8) = 1 * 8 = 8

Putting all the value into equation of credit creation,

Now, credit creation = $8000 * 8 = $64000

Q25) correct option - b) less than 100% of deposits as reserves.

In the fraction system bank have hold certain percentage of deposit as reserve which is also known as cash reserve requirement. Therefore bank can neither keep all the deposits as reserve nor they can lend all the deposits.