Question

Suppose the required reserve ratio is 20 percent. If banks are conservative and choose not to loan all their excess reserves, the real-world deposit multiplier is A) less than 5.B) equal to 5.C) greater than 5.D) equal to 20.

Answer 1

Option B

Explanation:

Given that the required reserve ratio is 20 percent.

Since banks are conservative they choose not to loan all their excess reserves

i.e. only 20% of deposits is kept as reserve and 80% lent.

This 80% will again be deposited in a bank and 80% of 80 i.e.64% would be lent. Thus this will form a geometric progression infinitely as

deposits
`= 1+0.8 + 0.8^2 +0.8^3+...`with common ratio 0.8<1

Hence infinite sum =
`(a)/(1-r) =(1)/(1-0.8) \\=5`

So deposit multiplier is B) equal to 5