Suppose that the required reserve ratio is 0.4. If a customer withdraws $10 million from a bank, then the money supply could potentially:

Question

Quizplus · Accepted Answer

When a customer withdraws $10 million from a bank, the bank must keep 40% of that as required reserves. Therefore, the bank can only lend out 60% (or $6 million) of the withdrawal. This means there is a potential decrease in the money supply of $6 million. However, as that $6 million circulates in the economy, it can potentially be deposited in another bank, which can then lend out 60% of that deposit, leading to a potential increase in the money supply of $3.6 million (60% of $6 million). Therefore, the overall potential decrease in the money supply is $6 million - $3.6 million = $2.4 million, or 0.024 times the original withdrawal amount of $10 million. Therefore, the correct answer is B.

Suppose That the Required Reserve Ratio Is 0