The banking system has $20 million in reserves and has a reserve requirement of 20 percent. The public holds $10 million in currency. Bankers previously did not hold any excess reserves, but difficult economic times make them decide that it is prudent to hold 25 percent of deposits as reserves. At the same time, the public decides to withdraw $10 million in currency from the banking system. Other things equal, by how much must the Bank of Canada increase bank reserves to keep the money supply the same?
A)$10 million
B)$12.5 million
C)$50 million
D)No action by the Bank of Canada is necessary.

Question

Quizplus · Accepted Answer

The public withdraws $10 million, reducing deposits and requiring banks to hold more reserves. To maintain the money supply, the Bank of Canada must increase reserves by $12.5 million to offset the withdrawal and increased reserve ratio.

The Banking System Has $20 Million in Reserves and Has