Question

Imagine that you deposit $25,000 in currency (which you had been storing in your closet), into your checking account at the bank. Assume that this institution has a required reserve ratio of 25%.

As a result of this deposit, what is the theoretical maximum amount in loans that can be made by all the banks (combined) in the commercial banking system?

a. $75,000
b. $18,750
c. $25,000
d. $100,000
e. $0

Answer 1

d) $100,000

Step-by-step explanation:

The maximum money that can be created from this deposit of $25,000 can be computed by calculating the credit multiplier.

Credit Multiplier = 1 / Reserve ratio = 1 / 0.25 = 4

This means a new deposit that was previously not in the circular flow creates 4 times as much money. Banks thus, are able to make loans equivalent to 4 * $25,000 = $100,000 which will be reflected in commercial banks around the system.

Hope that helps.