The reserve ratio is 20 percent. The Fed buys $1 million in government securities from a bond dealer by transmitting the funds to the dealer's deposit account at Bank A. Bank A loans the maximum amount possible to a construction company, which buys materials from a lumber yard. The lumberyard deposits the construction company's check in Bank B. What is the maximum loan Bank A can now make and the maximum loan Bank B can now make?

Question

Quizplus · Accepted Answer

The Fed's purchase of $1 million in government securities increases the reserves of Bank A by $1 million. Bank A can then lend out a maximum of 80% of this amount, or $800,000. The construction company's deposit of $800,000 in Bank B increases Bank B's reserves by $800,000. Bank B can then lend out a maximum of 80% of this amount, or $640,000.

The Reserve Ratio Is 20 Percent