Question

Suppose that the banking system has excess reserves of $10 million, the desired reserve ratio is 10 percent and the
currency drain ratio is 40 percent. By how much will the quantity of money increase?
A) $28 million.
B) $50 million.
C) $22 million.
D) $40 million.
E) $12.5 million.

Answer 1

Answer : The answer is option A.

Given,

Reserve = $10 million.

Desired reserve ratio = 10% = 0.1

Currency drain ratio = 40% = 0.4

Money multiplier = (1 + Currency drain ratio) / (Currency drain ratio + Desired reserve ratio)

=> Money multiplier = (1 + 0.4) / (0.4 + 0.1)

=> Money multiplier = 1.4 / 0.5

=> Money multiplier = 2.8

Money supply = Reserve * Money multiplier

=> Money supply = 10 * 2.8

=> Money supply = $28 million.

Therefore, here money supply increases by $28 million.

So, option A is correct.