If a bank uses $100 of excess reserves to make a new loan when the reserve ratio is 20 percent, this action by itself initially makes the money supply
A)and wealth increase by $100.
B)and wealth decrease by $100.
C)increase by $100 while wealth does not change.
D)decrease by $100 while wealth decreases by $100.

Question

Quizplus · Accepted Answer

When a bank uses excess reserves to make a new loan, the money supply increases due to the multiplier effect. In this case, the excess reserves are $100, and the reserve ratio is 20 percent, which means that the bank can make a new loan of $500 (100/0.2 = 500). Therefore, the money supply increases by $500, while wealth does not change since no assets or liabilities are exchanged.

If a Bank Uses $100 of Excess Reserves to Make