Question

Assume that $1 million is deposited in a bank with a reserve requirement of 15 percent....

Assume that $1 million is deposited in a bank with a reserve requirement of 15 percent. a. What is the money supply as a result?

The answer is 6.67 million, as the money multiplier equals 6.67 (1/0.15). My question is, why don't we have to subtract 150000 (the amount the bank must keep on hand) before we multiply? Ie: why is the answer not 850000 times 6.67?

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Answer #1

As given in the question answer is $6.67 million and money multiplier means that if there is a certain amount of deposit, the amount of money that the bank can actually use for lending purposes all in all is determined if there is a certain amount of deposit the bank can contact Federal Reserve for the money supply to give out loans where the reserves are kept at Fed. That is the reason why you just don't subtract the reserve as Federal Reserve supplies you with adequate amount.

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