Suppose you take $200 that you had kept under your pillow and deposit it in your

Question

Suppose you take $200 that you had kept under your pillow and deposit it in your bank account and the required reserve ratio is 10%. What is the money multiplier? What is the largest possible increase in the money supply? Suppose you take $500 that you had kept under your pillow and deposit it in your bank account and the required reserve ratio is 20%. What is the money multiplier? What is the largest possible increase in the money supply? Suppose you take $1000 that you had kept under your pillow and deposit it in your bank account and the required reserve ratio is 5%. What is the money multiplier? What is the largest possible increase in the money supply? The Federal Reserve conducts a $10 million open-market purchase of government bonds. If the required reserve ratio is 10%, what is the largest possible increase in the money supply that could result? Explain. What is the smallest possible increase? Explain.

Explanation / Answer

The relation between Money multiplier and Reserve ratio is,

Money Multiplier = 1 / Reserve ratio.

1) Money Deposited = $200

Required reserve ratio = 10% = 0.1

Money multiplier = 1/ Reserve ratio = 1 / 0.1 = 10

So the money supply can increase = Deposited amount x Money Multiplier = $200 x 10 = $2,000

2) Money Deposited = $500

Required reserve ratio = 20% = 0.2

Money multiplier = 1 / Reserve ratio = 1 / 0.1 = 5

So the money supply can increase = Deposited amount x Money Multiplier = $500 x 5 = $2,500

3) Money Deposited = $1000

Required reserve ratio = 5% = 0.05

Money multiplier = 1 / Reserve ratio = 1 / 0.05 = 20

So the money supply can increase = Deposited amount x Money Multiplier = $1000 x 20 = $20,000

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