Question

If the Central Bank of Macroland puts an additional 1,000 dollars of currency into the economy, the public deposits all currency into the banking system and banks have a desired reserve/deposit ratio of 0.20, then the banks will eventually make new loans totaling ______ and the money supply will increase by _______.

Answer 1

1. $4,000
2. $5,000

Step-by-step explanation:

First we have to determine the money multiplier of Macroland:

• money multiplier = 1 / 0.2 = 5

If $1,000 are deposited in banks and the banks have a 20% reserve ration, they will be able to lend $800. The $800 will then increase to $4,000 (= $800 x 5) because of the money multiplier.

The total increase in the money supply is given by the $1,000 deposited originally and the $4,000 in increased loans = $5,000