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In this scenario, how much more money could the bank create if it does not hold excess...

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Mizdee | Student, Undergraduate | (Level 1) Valedictorian

Posted October 15, 2012 at 3:51 AM via web

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In this scenario, how much more money could the bank create if it does not hold excess reserves? 

Suppose the required reserve ratio is .20 and individuals hold no cash.  Total bank deposits are $200 million and the bank holds $50 millions in reserves.

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted October 15, 2012 at 4:00 AM (Answer #1)

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First, we need to find out how much more the bank could lend if it did not hold excess reserves.  Total deposits are $200 million and the reserve requirement is .2.  Therefore, the bank must hold $40 million.  This means the bank could lend $10 million more.

Now, we need to know what the money multiplier is.  The multiplier is found through the equation

Multiplier = 1/reserve requirement.

1/.2 = 5.

So, the money multiplier is 5.  If the bank lends out the extra $10 million, its impact on the money supply will be multiplied by 5.  That means that the bank could create $50 million more if it lent its excess reserves.

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