Suppose you win on a scratch-off lottery ticket and you decide to put all of you

Question

Suppose you win on a scratch-off lottery ticket and you decide to put all of your $2,500 winnings in the bank. The reserve requirement is 10%. How much maximum of new money will be created (maximum amount of new checking deposits created by the banking system) as a result of your bank deposit? Which events could cause the increase in the money supply to be less than its potential? Check all that apply. Banks choose to loan out all excess reserves. Some loan recipients choose to hold some cash instead of depositing all of it in banks. Banks decide to keep some excess reserves on hand. All money loaned out is deposited back into the banking system.

Explanation / Answer

(1) Maximum new money ($) = (New deposit / Reserve ratio) - New deposit = (2,500 / 0.1) - 2,500 = 25,000 - 2,500

= 22,500

(2) Following events would increase money supply less than potential:

- Some loan recipients choose to hold some loan as cash (which is a drainage)

- Banks decide to keep some excess reserves in hand (thus loan is not maximized)

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