The following is information about a banking system: new currency deposited in the system = $40 billion; desired reserve ratio = 20%; excess reserves prior to the new currency deposit = $0.Refer to the above information.The total demand deposit after the expansion of the money supply through loans is:
A)$160 billion.
B)$200 billion.
C)$40 billion.
D)$128 billion.

Question

Quizplus · Accepted Answer

The desired reserve ratio is 20%, which means that the bank is required to hold 20% of the demand deposit in reserve. Prior to the new currency deposit, the excess reserves were $0, meaning that the bank was already holding the required reserve ratio. When the new currency is deposited in the system, the total reserves increase by $40 billion (20% of $40 billion is $8 billion, which is the amount of reserves that must be held). This means that the excess reserves will now be $32 billion ($40 billion - $8 billion = $32 billion). 
Using the money multiplier formula (1/RR), where RR is the reserve ratio, we can calculate the maximum amount of loans that can be made: 
Maximum loan = (1/0.20) x $32 billion = $160 billion
Therefore, the total demand deposit after the expansion of the money supply through loans is $200 billion ($40 billion initial deposit + $160 billion in loans = $200 billion).

The Following Is Information About a Banking System: New Currency