Suppose that a bank gets a new deposit of $100 cash and it has a 20% required reserve ratio. If the bank lends the maximum amount of money allowed, then the money supply (including the original deposit) increases by:

Question

Quizplus · Accepted Answer

With a 20% reserve ratio, the bank must keep $20 of the $100 deposit in reserve but can lend out $80. The $80 lent out can then be deposited in a bank, which can lend out 80% of that, and so on. This process continues, creating a multiplier effect. The formula for the maximum increase in the money supply is 1/reserve ratio, which in this case is 1/0.20 = 5. Therefore, the original $100 deposit can increase the money supply by up to $500 (5 times the original deposit), including the original deposit.

Suppose That a Bank Gets a New Deposit of $100