Suppose that the actual money multiplier equals the maximum potential money multiplier. If the reserve ratio is 10 percent, in order for the banking system to increase deposits by $2.5 million, the Fed must

Question

Quizplus · Accepted Answer

Since the actual money multiplier equals the maximum potential money multiplier, we can use the formula to find the amount of money that can be created given a change in reserves:

Change in deposits = (1/rr) x Change in reserves

where rr is the reserve ratio.

If the banking system wants to increase deposits by $2.5 million and the reserve ratio is 10%, we can plug in the numbers:

2,500,000 = (1/0.10) x Change in reserves

Change in reserves = $250,000

This means that the Fed must buy $250,000 of government securities from the public to increase reserves by that amount, which will allow the banking system to create an additional $2.5 million in deposits. Therefore, the correct choice is D.

Suppose That the Actual Money Multiplier Equals the Maximum Potential