Assume that all commercial banks are making the maximum amount of loans possible given a desired liquidity ratio of 25%. Total deposits in the banking system are £200 million. Assume that banks reduce their chosen liquidity ratio to 20%. The money supply will

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Quizplus · Accepted Answer

When banks reduce their liquidity ratio from 25% to 20%, they can lend out more money. The initial excess reserves are £200 million * 5% = £10 million. The money multiplier is 1/0.20 = 5. Therefore, the increase in the money supply is £10 million * 5 = £50 million.

Assume That All Commercial Banks Are Making the Maximum Amount