Assume that banks do not hold excess reserves. The banking system has $20 million in reserves and has a reserve requirement of 20 percent. The public holds $10 million in currency. Then the public decides to withdraw $5 million in currency from the banking system. If the Bank of Canada wants to keep the money supply stable by changing the reserve requirement, then what will the new reserve requirement be?
A) 16 percent
B) 18.2 percent
C) 20 percent
D) 25 percent

Question

Quizplus · Accepted Answer

The correct answer is A.The money supply is equal to the monetary base times the money multiplier. The monetary base is equal to reserves plus currency. The money multiplier is equal to 1 divided by the reserve requirement.If the public withdraws $5 million in currency from the banking system, the monetary base will decrease by $5 million. To keep the money supply stable, the Bank of Canada must increase the money multiplier by increasing the reserve requirement.The new reserve requirement will be 20 percent + (5 million / 20 million) = 25 percent.

Assume That Banks Do Not Hold Excess Reserves