At one time, the country of Sylvania had no banks, but had currency of $10 million. Then a banking system was established with a reserve requirement of 20 percent. The people of Sylvania now keep half their money in the form of currency and half in the form of bank deposits. If banks do not hold excess reserves, how much currency do the people of Sylvania now hold?
A)$2 million
B)$5 million
C)$8.33 million
D)$9.09 million

Question

Quizplus · Accepted Answer

Initially, the total currency in circulation was $10 million. When the banking system was established with a 20% reserve requirement, $2 million (20% of $10 million) was held as reserves, and $8 million was available for lending.

If people now hold half of their money in the form of currency and half in the form of bank deposits, then the currency in circulation will reduce proportionately. Half of the original $10 million currency, which is $5 million, will now be held as currency by the people.

Since banks do not hold excess reserves in this scenario, the remaining half of the money, which is also $5 million, will be deposited in the bank. Therefore, the people of Sylvania now hold $5 million currency, and the remaining $5 million is held as deposits in the bank.

Hence, the correct answer is (C) $8.33 million.

At One Time, the Country of Sylvania Had No Banks