If the Fed buys a $100,000 government security from a bank when the desired reserve ratio is 10 percent and the currency drain is 50 percent, the bank can loan a maximum of
A) $50,000.
B) $40,000.
C) $100,000.
D) $90,000.
E) $60,000.

Question

Quizplus · Accepted Answer

When the Fed buys a government security, the bank's reserves increase by the same amount. Given the desired reserve ratio is 10%, the bank must keep 10% of its deposits as reserves. Therefore, the maximum amount it can lend is:

$100,000 (increase in reserves) x 50% (currency drain) x 90% (required reserves) = $45,000

Subtracting this from the $100,000 the bank originally received gives us:

$100,000 - $45,000 = $55,000

Therefore, the bank can lend a maximum of $55,000, but it's important to note that this is not one of the answer choices. The closest answer choice is D, $90,000, which is higher than the actual maximum amount the bank can lend.

If the Fed Buys a $100,000 Government Security from a Bank