Question

Suppose that the excess reserves in Toronto Dominion Bank increase by $700. Given a desired reserve ratio of 2.5% and no cash drain, the maximum change in deposits for the entire banking system would be

A) $682.50.
B) $700.00.
C) $17,500.00.
D) $28,000.00.
E) $70,000.00.

Answer 1

The maximum change in deposits given the excess reserves of $700 and a reserve ratio of 2.5% would be $28,000.00, calculated using the money multiplier, which is the reciprocal of the reserve ratio.

Step-by-step explanation:

The student's question pertains to the maximum change in deposits for the banking system when Toronto Dominion Bank's excess reserves increase by $700, given a desired reserve ratio of 2.5% and no cash drain. To calculate the maximum change in deposits, we use the money multiplier formula. The money multiplier (also known as deposit expansion multiplier) is the reciprocal of the reserve ratio.

Hence, the money multiplier here is 1 divided by 0.025 which equals 40. Using the money multiplier, we then multiply the excess reserves by the multiplier to calculate the maximum potential change in deposits. Therefore the maximum change in deposits would be $700 (excess reserves) x 40 (money multiplier) which equals $28,000.00. Option D) $28,000.00 is the correct answer.