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The Federal Reserve wants to increase the money supply by printing and distributing 1 million dollars...

The Federal Reserve wants to increase the money supply by printing and distributing 1 million dollars worth of currency notes. What will be the actual increase in money supply if the public holds one-fourth of the currency as cash, and deposits rest of the money in banks that hold 5 percent of their deposits as reserves?

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Answer #1

Currency hold by public= (1/4) x 1 million= 250,000

Remaining amount deposited into bank:

Deposit= 1 million - 250,000= 750,000

Through the process of money creation banking system can increase money supply manyfold through this initial deposit.

Money creation by bank= initial deposit x 1/Reserve requirement= 750,000 x 1/5%= 750,000 x 20= 15,000,000

Reserve out of total money creation= 15,000,000 x 0.05= 750,000

Total Loan amount = 14,250,000

Increase in money supply= 250,000+14,250,000= 15,000,000

The initial printing of money of 1 million cause money supply to increase by 15,000,000.

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