Question

Explain how banks can increase the money suppply ina fractional reeserve system given an intitial injection of $ 100 billion USD in deposits and a required reserve ration of 10%

Answer 1

From theory, we knew that,

the change in money supply = Amount of excess reserve * Money Multiplier.

Here, due to an initial injection of $100 billion, given the required reserve ratio of 10% or 0.10, the required reserve would be ($100 * 0.10) = $10 billion.

Now, excess Reserve = Total Reserve - Required Reserve

Excess Reserve = ($100 - $10) billion = $90 billion.

Now, money multiplier = (1 / required reserve ratio).

Now, change in money supply due to an increase in deposits of $100 billion is,

the change in money supply = $90 billion * (1 / 0.10) = $900 billion.

Due to an initial injection of $100 billion in deposits would result in an increase in money supply by $900 billion.