Question

3) Suppose the required reserve ratio is 20%.

a. How much money must be kept in reserves for a $200 deposit.

b. How much money can the bank loan out after a $200 deposit is made?

c. What is the maximum amount of total money supply that can be created from an initial deposit of $200? Show your work.

d. In general, why might the actual amount of total money creation be less than the maximum?

Answer 1

a. $40 must be kept in reserves for a $200 deposits.

Explanation

Required reserve ratio = 20%

Deposits amount = $200

Amount of reserves = 20% of $200 = .20 * 200 = $40

b. $160

Explanation

The bank loan can be made after deduction of required reserves = $200 - ( .20 * 200 ) = $160

c. $ 1000

Explanation

Iinitial deposits = $200

Required reserve ratio = 20% or .20

Money multiplier = 1 / .20 = 5 ( inverse value of resereve ratio)

So maximum money supply can be created = $200 * 5 = $ 1000

d. In gneral the actual amount of total money creation might be less than the maximum due to excess reserves apart from required reserves maintained by bank.