Question

Assume that the banking system has total reserves of $100 billion. Assume also that required reserves are 10 percent of checking deposits, and that banks hold no excess reserves and households hold no currency. a. What is the money multiplier? What is the money supply? b. If the Fed now raises required reserves to 20 percent of deposits, what is the change in reserves and the change in the money supply?

Answer 1

a) multiplier 10

b) money supply 1,000B

c) if the FED raises to 20% the minimum reverse ratio:

mutiplier 5

money suply 500B

Step-by-step explanation:

a) the multiplier is 1 over the required reserve ratio as it assumes banks will lend all the cash above this threshold

1/0.1 = 10

b) money supply: reserve times mutiplier:

100 x 100 = 1,000 billions

c) if required reserve ratio incerase to 20% then:

multiplier 1/0.2 = 5

and money supply 100 x 5 = 500 billions

Answer 2

The money multiplier is the amount of money that is generated from the reserves of a bank:
$100/0.10 - $100 = $900 billion
The money supply is
$100/0.10 = $1000 billion of $1 trillion
If the reserves is changed to 20%, the money multiplier and money supply will decrease