Question

suppose a bank has all of its excess reserves lent out. then a large corporation deposits $400 million into the bank. if the required reserve ratio is 10 percent, by how much can deposit creation ultimately add to the money supply?

Answer 1

The bank must keep $40 million of the $400 million deposit as required reserves and can lend out the remaining $360 million. This could lead to a potential increase in the money supply of up to $4 billion due to the deposit multiplier effect, with a money multiplier of 10 based on the 10% reserve requirement.

Step-by-step explanation:

If a large corporation deposits $400 million into a bank that has all of its excess reserves already lent out, and the required reserve ratio is 10%, the bank must keep $40 million (10% of $400 million) as required reserves. The rest, which is $360 million (90% of $400 million), can be lent out. This initial lending will increase the money supply by $360 million. However, as these funds are deposited and re-lent throughout the banking system, they will create additional money through the multiplier effect. The total increase in the money supply, also known as the maximum potential expansion of deposits created by this deposit, can be calculated using the money multiplier formula: 1 / Reserve Requirement. In this case, it would be 1 / 0.10, which equals 10. Thus, the total increase in the money supply can potentially be up to $4 billion ($400 million multiplied by the money multiplier of 10).

Answer 2

A $400 million deposit with a 10% reserve ratio could potentially increase the money supply by $4 billion through the deposit multiplication effect.

Step-by-step explanation:

When a large corporation deposits $400 million into a bank, and the required reserve ratio is 10%, the bank must hold $40 million as required reserves. The rest, which is $360 million, can be lent out. This lending process can be repeated multiple times by various banks, where each time, 10% is kept in reserve and 90% is loaned out. This is known as the deposit multiplication effect in the banking system.

The total increase in the money supply will ultimately be determined by the money multiplier formula, which is 1 divided by the reserve requirement ratio. Given a reserve requirement of 10% (or 0.10), the money multiplier is 1 / 0.10 = 10. Therefore, the deposit of $400 million can eventually lead to a maximum increase in the money supply of 400 million * 10 = $4 billion.