Question

Assume that the banks do not hold any excess reserves and the reserve ratio is 20%. If Sarah deposits $5,000 in cash in her checking account, the money supply can potentially increase by:

1.) $25,000
2.) $5,000
3.) $1,000
4.) $20,000

Answer 1

The correct answer is option 4.

Step-by-step explanation:

The banks do not hold any excess reserves.

The required reserve ratio is 20%.

Sarah deposits $5,000 in cash in her checking account.

The banks reserves will increase by

= $5,000 - 20% of $5,000

= $5,000 - $1,000

= $4,000

This will cause the money supply to increase by

=
`(1)/(RR)* Change\ in\ reserves`

=
`(1)/(0.2)* \$ 4,000`

= $20,000