Suppose you found $3,000 hidden in your closet and deposited it in a demand deposit account at your bank. If the reserve requirement was 40 percent, the deposit would directly create ____ in excess reserves and ultimately lead to a ____ total increase in the money supply, if all banks in the system lend out 100 percent of their excess reserves.

Question

Quizplus · Accepted Answer

The deposit of $3,000 increases the bank's reserves by $3,000. With a 40% reserve requirement, the bank must keep $1,200 (40% of $3,000) as required reserves, leaving $1,800 ($3,000 - $1,200) as excess reserves. This $1,800 can be lent out, creating a potential total increase in the money supply through the money multiplier effect. The money multiplier is 1 divided by the reserve requirement ratio, which is 1/0.4 = 2.5. Therefore, the total increase in the money supply is $1,800 * 2.5 = $4,500. However, the initial deposit also counts towards the money supply, so the total increase is $3,000 (initial deposit) + $4,500 (created through lending) = $7,500.

Suppose You Found $3,000 Hidden in Your Closet and Deposited