Question

If the money multiplier is 4, what is the required reserve ratio (RRR)?

25 percent
50 percent
2 percent
20 percent

Answer 1

The Answer is:

A: 25%

Answer 2

The money multiplier is the inverse of the required reserve ratio. The inverse of 4 is 1/4, so 25%.

`Money multiplier = (1)/(RRR)`

The money multiplier is the maximum effect bank deposits can have on the money supply if their amounts change. For example, if deposits increase, the money multiplier is the ratio of the increase in money supply to this increase in deposits.

In the U.S., the required reserve ratio is set by the Federal Reserve. It is the fraction of money which a bank is asked to keep in reserves (not loan out) out of what is deposited. If the RRR is 2 to 10, a bank will have to hold in reserve $0.20 of every dollar that is deposited.

With a high RRR, banks can loans out less money, and the money multiplier is low, and vice versa.