Suppose the desired reserve ratio is 20 percent, and the Bank of Canada buys a $10,000 security from a depository institution that currently has no excess reserves.How is the money supply affected, using the simple multiplier?

Question

Quizplus · Accepted Answer

The simple multiplier formula is 1/required reserve ratio. In this case, the required reserve ratio is 20%, so the multiplier is 1/0.2 = 5. When the Bank of Canada buys the $10,000 security, the depository institution receives $10,000 in reserves. Since it had no excess reserves before, it must hold onto the required reserves of $2,000 (20% of $10,000). This means it can lend out the remaining $8,000. Using the multiplier, we can calculate that the money supply will increase by 5 times that amount, or $40,000. Adding the initial $10,000 in reserves from the Bank of Canada's purchase, the total increase in the money supply is $50,000. So, the correct answer is C.

Suppose the Desired Reserve Ratio Is 20 Percent, and the Bank