Question

If the reserve requirement is 20 percent, and banks keep no excess reserves, an increase in an initial inflow of $100 into the banking system will cause an increase in the money supply of______.

A. $20.
B. $50.
C. $100.
D. $500.

Answer 1

The correct answer is D)$500

Step-by-step explanation:

First, we need to find the rate at which the banking system can create money with a reserve requirement of 20%. Letting rr stand for reserve requirement, we write:

(1/20%) x $100 = 5

Therefore, banks are able to create 5 times from its initial inflow of $100 under a reserver requirement of 20%.

$100 X 5 = $500.