Question

Suppose that you are in an economy with reserve requirements are equal to 26%, and cash drain is equal to 16%. This economy currently has $4,000 total banking deposits in the banking system. All of the banks have zero capital. If the Central Bank lowers the reserve requirements from 26% to 18%, then what will be the increase in the quantity of total bank deposits in the banking system?

Answer 1

When the Central Bank lowers the reserve requirements from 26% to 18%, the increase in the quantity of total bank deposits in the banking system will be $500.

Step-by-step explanation:

When the Central Bank lowers the reserve requirements from 26% to 18%, it effectively reduces the amount of money that banks are required to hold as reserves. As a result, banks will have more money available to lend out. The increase in the quantity of total bank deposits in the banking system can be calculated using the cash drain multiplier formula:

Change in Total Bank Deposits = Change in Reserves / Cash Drain

Since the reserves decrease by 8% (26% - 18%), the change in reserves is 0.08 multiplied by the initial amount of total bank deposits ($4,000). The cash drain is given as 16%. Plugging these values into the formula, we have:

Change in Total Bank Deposits = 0.08 * $4,000 / 0.16 = $500

Therefore, the increase in the quantity of total bank deposits in the banking system will be $500.