a. The following table represents the balance sheet of a bank showing the effect of the loan made by the bank after all excess reserves have been loaned out: The money supply will increase by a maximum of $900 (i.e., $90/.10).
To understand this concept, we need to keep in mind that the money supply is generated by the lending of money by the banks. The money multiplier is the ratio of the money supply to the monetary base. The monetary base is also called high-powered money, which is the sum of the currency in circulation and bank reserves.
= 1/Required Reserve Ratio. The required reserve ratio is the percentage of deposits that banks must keep as reserves. Thus, if the required reserve ratio is 10%, banks can lend 90% of their deposits. The money multiplier can be calculated as follows: Money Multiplier
= 1/0.10
= 10.The money supply is given by the formula: Money Supply
= Money Multiplier × Monetary Base.
= 10 × $100
= $1,000.The maximum possible increase in the money supply, in this case, is equal to the change in the monetary base, which is the loan made by the bank, divided by the reserve requirement. Thus, the maximum possible increase in the money supply is $900.c.
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