Question

If a bank receives a new deposit of $10,000, and the required reserve ratio is 25 percent, then the new money that can be created by the banking system, including the initial deposit, is: a. $4,000. b. $10,000. c. $40,000. d. $2,500. e. $25,000.

Answer 1

C. 40000

Step-by-step explanation:

As per Money Multiplier / Credit Creator :

Total Money Creation = (1/Legal Reserve Ratio) times Initial Deposits

(1/0.25) i.e 4 times Initial Deposits = 4 X 10000 = 40000

Money Multiplier Working : It is based on assumptions that - Entire banking system is unified , all payments & receipts go through bank.

Suppose: With new deposits $1000, LRR proportion (CRR & SLR i.e mandated to be kept by banks with themselves ,banks respectively) - i.e 25% = $250 is retained & remaining $750 is lended . Lent funds $750 are spent by borrower , which are received in someone else's bank account (one person expenditure is other person income & assumption) . Again , 20% of these deposited $750 i.e $150 is retained & remaining $600 is lended again. These $600 spent & received by someone further create deposit again.

This process goes in till : Final Deposits = 1/LRR X Initial deposits (100) and become $400