Suppose that there is a $2 million increase in excess reserves, and the reserve requirement is 5%. What happens to the money supply?
A) The money supply increases by $100,000.
B) The money supply increases by $40 million.
C) The money supply increases by $10 million.
D) The money supply increases by $1 million.

Question

Quizplus · Accepted Answer

The money supply increases by more than the initial increase in excess reserves due to the money multiplier effect. The money multiplier is 1 divided by the reserve requirement ratio. In this case, it's 1 / 0.05 = 20. Therefore, a $2 million increase in excess reserves can potentially increase the money supply by 20 times that amount, which is $40 million.

Suppose That There Is a $2 Million Increase in Excess