Question

Suppose the current reserve requirement for bank deposits is 10%. You deposit $100 in your bank and the bank must retain 10% of your deposit on reserve. Assuming the bank does not wish to retain any excess reserves, by how much did your $100 deposit increase the money supply?

Answer 1

A $100 deposit with a 10% reserve requirement can increase the money supply by up to $1000, using the money multiplier effect which calculates the maximum potential increase in money supply.

Step-by-step explanation:

When a person deposits $100 at a bank with a 10% reserve requirement, the bank must keep $10 as reserves and can lend out $90. This $90 can then be deposited in another bank, which must keep 10% ($9) and can lend out $81. This process continues, with each iteration decreasing the loanable amount by 10%. The total increase in the money supply is therefore calculated using the money multiplier, which is 1 divided by the reserve ratio—so in this case, 1 / 0.10, or 10. The initial $100 deposit could ultimately lead to an increase in the money supply of up to $1000 once the money multiplier effect is complete.