Consider the following situation in the Canadian banking system:
∙ The Bank of Canada purchases $5 million worth of government securities
from an investment dealer with a cheque drawn on the Bank of Canada.
∙ The dealer deposits this cheque at Bank XYZ,a commercial bank.
∙ The target reserve ratio for all commercial banks is 25%.
∙ All commercial banks operate with no excess reserves.
∙ There is no cash drain.
TABLE 26-4
-Refer to Table 26-4.Suppose the public decides to hold 15% of their deposits in cash - that is,there is now a cash drain of 15%.As a result of the new deposit,the money supply would eventually

Question

Quizplus · Accepted Answer

The initial deposit of $5 million will lead to a money multiplier effect. With a reserve ratio of 25% and a cash drain of 15%, the effective reserve ratio becomes 40%. The money multiplier is 1/(0.25 + 0.15) = 2.5. Thus, the money supply increases by $5 million * 2.5 = $12.50 million.

Consider the Following Situation in the Canadian Banking System