Final answer:
The value of the money multiplier indicates how much the money supply can increase based on the reserve ratio. With a multiplier of 8, a $1000 deposit can lead to a maximum expansion of the money supply by $8000, assuming banks lend out all excess reserves.
Step-by-step explanation:
The question deals with the concept of the money multiplier in the banking system. The money multiplier represents how much the money supply can potentially increase based on the reserve ratio set by the central banking authority. To calculate this, we use the formula for the money multiplier which is 1 divided by the reserve requirement ratio. In this case, we are given that the money multiplier is equal to 8. Therefore, the reserve ratio is 1/8, or 0.125 (12.5%).
When Smith deposits $1000 into her checking account, this initial deposit represents an increase in the bank's reserves. Since banks are only required to keep a fraction of deposits as reserves (the reserve ratio we've found), they can loan out the remainder.
The maximum possible expansion in the money supply occurs when these loans are deposited into other accounts, creating a cycle of depositing and lending. With a money multiplier of 8, Smith's $1000 deposit could potentially result in an expansion of the overall money supply by $8000 (8 times the original deposit), assuming that banks lend out all excess reserves