Consider the following information about a banking system: new currency deposited in the system = $40 billion, legal reserve ratio = 0.20, excess reserves prior to the currency deposit = $0. With the $40 billion deposit, the
Banking system will be able to expand the money supply through loans by
A) $160 billion.
B) $200 billion.
C) $40 billion.
D) $128 billion.

Question

Quizplus · Accepted Answer

The money multiplier is 1 divided by the reserve ratio, which is 1/0.20 = 5. The potential increase in the money supply is the initial deposit multiplied by the money multiplier: $40 billion * 5 = $200 billion. However, since the $40 billion is already part of the money supply, the net expansion through loans is $200 billion - $40 billion = $160 billion.

Consider the Following Information About a Banking System: New Currency