The reserve ratio is 20 percent. After the Fed buys $1 million in U.S. government securities from a bond dealer by transmitting the funds to the dealer's deposit account at Bank A, Bank A lends a construction company an amount equal to its excess reserves. The construction company spends the entire amount on lumber from a lumber yard, which deposits the construction company's check in its deposit account with Bank A. The maximum loan Bank A can now make is

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The initial deposit of $1 million increases Bank A's reserves by $1 million. The reserve ratio is 20%, so Bank A's excess reserves are $1 million x 0.20 = $200,000. Bank A lends this amount to the construction company, which spends it on lumber. The lumber yard deposits the check in its account at Bank A, increasing Bank A's reserves by another $200,000. Bank A's total excess reserves are now $400,000. The maximum loan Bank A can now make is $400,000 x 5 = $2 million. However, Bank A has already lent $200,000 to the construction company, so the maximum additional loan it can make is $2 million - $200,000 = $1.8 million. Since the question asks for the maximum loan Bank A can make, the answer is $1.8 million, which is closest to choice B, $640,000.

The Reserve Ratio Is 20 Percent