Suppose that a banking system has $10,000,000 in demand deposits and actual reserves of $1,200,000.If the target reserve ratio for all banks is 10 percent,what is the maximum possible expansion of the money supply?

Question

Quizplus · Accepted Answer

The maximum possible expansion of the money supply can be calculated using the money multiplier formula: Money Multiplier = 1 / Reserve Ratio. In this case, the reserve ratio is 10%, so the money multiplier is 1 / 0.10 = 10. This means that for every dollar of actual reserves, the banking system can create $10 of new money through lending. Therefore, the maximum possible expansion of the money supply is:
Max Money Supply Expansion = Money Multiplier x Actual Reserves
Max Money Supply Expansion = 10 x $1,200,000 = $12,000,000
However, this is the maximum possible expansion if all banks lend out their excess reserves. In reality, banks may choose to hold onto some of their reserves rather than lending them all out, so the actual expansion of the money supply may be less than the maximum possible expansion. Therefore, the closest option is E, $2,000,000, which is less than the maximum possible expansion but still a valid answer.

Suppose That a Banking System Has $10,000,000 in Demand Deposits