Question

If the desired reserve/deposit ratio equals 0.10, then every dollar of currency in bank reserves supports ______ of deposits and the money supply, while every dollar of currency held by the public contributes ______ to the money supply.

a) $1; $10
b) $1; $0.10
c) $0.10; $1
d) $10; $1

Answer 1

With a reserve/deposit ratio of 0.10, every dollar in bank reserves supports $10 of deposits in the money supply, while each dollar held by the public adds $1 to the money supply. The correct answer is c) $0.10; $1.

Step-by-step explanation:

If the desired reserve/deposit ratio equals 0.10, then every dollar of currency in bank reserves supports $10 of deposits and the money supply, while every dollar of currency held by the public contributes $1 to the money supply.

This can be better understood by looking at the concept of the money multiplier, which in this case is equal to 1 divided by the reserve ratio of 0.10, resulting in a multiplier of 10.

This means that for every dollar in reserves, banks can support $10 in deposits. Conversely, currency held by the public does not have a multiplying effect on the money supply, so each dollar held outside of the banks contributes only that dollar to the money supply.

If the desired reserve/deposit ratio equals 0.10, then every dollar of currency in bank reserves supports $10 of deposits and the money supply, while every dollar of currency held by the public contributes $1 to the money supply.