Question

Suppose the Federal Reserve purchases financial assets worth $10 from H&G Bank. This expansionary monetary policy causes the supply of money to increase by $100. If there are no cash holdings within this economy, and banks loan out all their excess reserves, then what is the required reserve ratio?

Answer 1

10%

Step-by-step explanation:

the effects of an expansionary monetary policy are determined by the following formula:

total effect = money injection x money multiplier

• total effect =$100
• money injection = $10
• money multiplier = $100 / $10 = 10

the formula for calculating the money multiplier = 1 / reserve ratio

10 = 1 / reserve ratio

reserve ratio = 1 / 10 = 10%

The required reserve ratio is the fraction of total deposits that banks are required to hold as cash, and cannot lend or invest. This money is to be held by the banks in order for them to have enough money to return to their clients if they want to withdraw their money.