If a bank uses $100 of excess reserves to make a new loan when the reserve ratio is 25 percent,what happens to the money supply in the very short term?
A) It decreases by $100.
B) It increases by $25.
C) It decreases by $25.
D) It increases by $100.

Question

Quizplus · Accepted Answer

When the bank makes a new loan of $100, it increases the money supply by $100. Since the reserve ratio is 25 percent, the required reserves increase by $25 (25% of $100). However, the bank had excess reserves of $100, so it can meet the new requirement by using its excess reserves. Therefore, there is a net increase of $100 in the money supply.

If a Bank Uses $100 of Excess Reserves to Make