Question

Some economists have advocated replacing government deposit insurance with 100-percent reserve banking. Under this plan, banks would hold all deposits as reserves. Deposit insurance would no longer be necessary because banks would always have the reserves to meet customer withdrawals.

a. What would happen to the money supply (defined as currency and bank deposits) in the transition from fractional reserve to 100-percent reserve, if this plan were implemented, holding other factors constant?

b. What will be the value of the money multiplier?

Answer 1

a. There will be no change in the money supply that is caused by depositing money in bank accounts. Meaning, when people deposit money in their bank's account, banks cannot loan out money from that deposit which causes the money supply to stay the same. money supply = deposit * Money multiplier.

Money multiplier = 1/reserve ratio

Let's say the reserve ratio is 20% and someone deposits $1000 dollars in the bank.

Money multiplier = 1/20%

=5

Money supply = 1,000 * 5

= 5,000

1,000 deposit will cause the money supply to increase by 5000. But if the reserve ratio is 100%, there will be no change in money supply through deposits

b. money multiplier = 1/ reserve ratio

reserve ratio = 100%

Money multiplier = 1/100%

= 1

Which means $1,000 deposit will only increase the money supply by $1000 which is taken from cash part of money supply