Question

Consider a country where all money is currently held as cash and the money supply has a value of $2,200. A banking system is developed, and the residents of the country deposlt the $2,200 of cash into the banking system and decide they no longer want to hold any cash. If the reserve ratio is equal to 4%, then the banking system has the ability to create $_________ money supply in the economy will be equal to $__________

Answer 1

Answer: the banking system has the ability to create $52,800 of new money and the money supply in the economy will be equal to $55,000

Step-by-step explanation:

To find out how much new money was created or rather how much can be created you can use the Money Multiplier. The money multiplier enables one to see how much money can be created in an economy given a certain reserve ratio.

The Money Multiplier is calculated by,

= 1/reserve requirement

Multiplying the Money Multiplier with the initial deposit in the bank gives the amount that that deposit can create.

With a Reserve Requirement of 4%, the Money Multiplier is,

= 1/4%

= 25

The Amount of money created in the economy is therefore,

= 25 * 2,200

= $55,000

The amount of New Money created will be the amount created less the initial deposit,

= 55,000 - 2,200

= $52,800