Chapter 25, Problem 3CYU

To determine

The way by which bank can expand if reserve ratio falls from 20% to 10%,

Explanation of Solution

Given Information:

Current reserve amount is $200

Total checkable deposits are $1000

Reserve ratio falls from 20% to 10%

Banks expand their deposits through lending. If reserve ratio is decreased then the excess amount kept in the reserve is released which can be used by the banks for further lending. Also, expansion of money supply can be determined by multiplying the excess reserve and the money multiplier.

In this, money multiplier is 10(1/.10) and excess reserve is $100 ($200-($1000*10%)). The expansion of money supply will be 10 x $100 i.e. $1000.

Economics Concept Introduction

Federal Reserve System: It is a central bank that looks after the banking system of the country along with the control of its monetary base. Monetary base is the sum of circulating currency and the reserves in the bank.

Required reserve ratio: Required reserve ratio refers to the portion of the total money deposits that is collected by the banks. This amount cannot be used for further lending or investing purpose. The percentage is decided by the Federal Reserve.