If a bank uses $500 of excess reserves to make a new loan when the reserve ratio is 20 percent, what happens to the money supply in the very short term?

Question

Quizplus · Accepted Answer

When the bank uses $500 of excess reserves to make a new loan, it effectively creates new money in the economy. Since the reserve ratio is 20%, the bank is able to create 5 times the amount of the excess reserves in loans, which is $2,500. This $2,500 increases the money supply in the very short term. Therefore, the correct answer is option D, which states that the money supply increases by $500.

If a Bank Uses $500 of Excess Reserves to Make