Assume a simplified banking system subject to a 20 per cent minimum liquidity requirement. If there is an initial increase in excess reserves of $100 000, the money supply:
A) increases $100 000.
B) increases $500 000.
C) increases $600 000.
D) decreases $500 000.

Question

Quizplus · Accepted Answer

With a 20% minimum liquidity requirement, banks must keep 20% of deposits as reserves and can lend out 80%. The initial increase in excess reserves of $100,000 can be lent out, and through the money multiplier effect (1/required reserve ratio = 1/0.20 = 5), the total increase in the money supply is $100,000 * 5 = $500,000.

Assume a Simplified Banking System Subject to a 20 Per