Suppose that the banking system does NOT hold excess reserves and the reserve ratio is 25%. If Molly deposits $1,000 cash in her checking account, the banking system can increase the money supply by an additional:

Question

Quizplus · Accepted Answer

The reserve ratio is 25%, which means that the bank is required to hold 25% of any deposit as reserves and can lend out the other 75%. When Molly deposits $1,000, the bank can lend out $750 of it (75% of $1,000) and must hold the remaining $250 as reserves. The person who borrows the $750 will deposit it in another bank account, and that bank can lend out 75% of that deposit, which is $562.50. This process can continue, with each bank holding 25% of the deposit as reserves and lending out 75% of it, until the total increase in the money supply is $3,000. Therefore, the correct answer is C) $3,000.

Suppose That the Banking System Does NOT Hold Excess Reserves