Suppose the Federal Reserve increases bank reserves and banks lend out some of these reserves,but at some point banks still have $5 million more they wish to lend out.If the reserve requirement is 10 percent,how much more money can banks create if they lend out the remaining amount?
A)$55 million
B)$50 million
C)$45 million
D)$40 million

Question

Quizplus · Accepted Answer

If the Federal Reserve increases bank reserves and banks lend out some of these reserves, the money supply can be expanded by the money multiplier effect. The money multiplier is the reciprocal of the reserve requirement. In this case, the reserve requirement is 10 percent, so the money multiplier is 1/0.1 = 10.

If banks have $5 million more they wish to lend out, they can lend out the $5 million and create 10 times that amount of deposits, which is $50 million (5 million x 10). Therefore, the total amount of money banks can create is $50 million.

Suppose the Federal Reserve Increases Bank Reserves and Banks Lend