Question

If the target reserve ratio in the banking system is 20%, there is no cash drain, and there are no excess reserves, a new deposit of $1 will lead to an eventual expansion of the money supply of

A) $0.20.
B) $1.20.
C) $2.00.
D) $5.00.
E) $20.00.

Answer 1

If the target reserve ratio in the banking system is 20%, a new deposit of $1 will lead to an eventual expansion of the money supply of $5.00.

Step-by-step explanation:

If the target reserve ratio in the banking system is 20%, a new deposit of $1 will lead to an eventual expansion of the money supply. This is because banks are required to hold reserves equal to a certain percentage of their deposits. In this case, with a reserve ratio of 20%, the bank will keep $0.20 as reserves and lend out the remaining $0.80. The borrower of this $0.80 will then deposit it into another bank, which will again keep $0.16 as reserves and lend out $0.64. This process will continue, with each bank keeping a fraction of the new deposit as reserves and lending out the rest, until the expansion of the money supply reaches its limit. In this scenario, the eventual expansion of the money supply from the initial $1 deposit will be $5.00, which is option D.