The banking system has deposits of $100 billion and no excess reserves. The required reserve ratio is 12.5 percent. A deposit of $10 billion in new money is made in Bank A, and no other bank in the banking system loses reserves. The maximum increase in checkable deposits that can be brought about by Bank A is a. $8.75 billion. b. $8.5 billion. c. $10.0 billion. d. $1.5 billion. e. $1.25 billion.

Expert Answers

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I do not think that the right answer is given in these options.  Here is how it should work:

There is a new deposit of 10 billion, but the bank will have to keep 12.5% of that as required reserves.  The bank will have to keep 1.25 billion.  There will be 8.75 billion of excess reserves.

So now to find the increase in the money supply brought about by Bank A, we multiply the change in excess reserves by the money multiplier.

Multiplier = 1/.125 = 8

So we multiply 8.75*8.  That gives us $70 billion.

$8.75 billion would be right if the question asked how much  the bank could loan but that is not what is being asked here and I can see no reason why the multiplier should not be used.

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