Question

Using a required reserve ratio of 10% and assuming that banks keep no excess reserves, which of the following scenarios produces a larger increase in the money supply? Explain why.

Someone takes $1,000 from under his or her mattress and deposits it into a checking account.

Answer 1

When $1,000 is deposited into a checking account, it leads to a larger increase in the money supply compared to keeping the money as currency.

Step-by-step explanation:

When someone takes $1,000 from under their mattress and deposits it into a checking account, the money supply increases by a larger amount compared to if the money had been kept as currency. This is because banks are required to hold a fraction of deposits as reserves. In this case, with a required reserve ratio of 10%, the bank would be required to keep $100 as reserves and can lend out the remaining $900. This $900 loan can then be deposited into another account, and the process continues, leading to a larger increase in the money supply.