Assume that banks lend out all their excess reserves.Currently, the legal reserves that banks must hold equal $11.5 billion.If the Federal Reserve decreases its reserve requirement from 10 percent to 5 percent, then there is potential for the whole banking system to raise the money supply by:

Question

Quizplus · Accepted Answer

If the reserve requirement decreases from 10% to 5%, banks will have to hold fewer reserves relative to their deposits. This means that they will have more excess reserves to lend out, which can potentially increase the money supply.

Currently, banks hold $11.5 billion in required reserves, which means they have $115 billion ($11.5 billion ÷ 0.10) in total deposits. If the reserve requirement decreases to 5%, banks will only have to hold $5.75 billion ($115 billion x 0.05) in required reserves, which means they will have $5.75 billion in excess reserves to lend out.

Assuming that banks lend out all their excess reserves, the potential for the whole banking system to raise the money supply is $5.75 billion x 20 (the reciprocal of the new reserve requirement of 5%) = $115 billion. Therefore, the correct answer is C) $115 billion.

Assume That Banks Lend Out All Their Excess Reserves