If a bank uses $80 of excess reserves to make a new loan when the reserve ratio is 25 percent,what happens to the money supply in the very short term?
A)It decreases by $80.
B)It increases by $20.
C)It decreases by $20.
D)It increases by $80.

Question

Quizplus · Accepted Answer

When a bank uses its excess reserves to make a loan, it increases the money supply by the amount of the loan. In this case, the bank is making a loan of $80, which means that the money supply will increase by $80.

The reserve ratio is the percentage of deposits that banks are required to hold in reserve. In this case, the reserve ratio is 25 percent, which means that banks are required to hold 25 percent of their deposits in reserve.

Since the bank is using $80 of excess reserves to make a loan, this means that the bank has $320 in deposits. ($80/.25 = $320)

When the loan is made, the borrower receives $80, which means that the money supply in the economy has increased by $80.

If a Bank Uses $80 of Excess Reserves to Make