The banking system has $20 million in reserves and has a reserve requirement of 20 percent. The public holds $20 million in currency. Bankers previously did not hold any excess reserves, but difficult economic times make them decide that it is prudent to hold 25 percent of deposits as reserves. At the same time, the public decides to deposit $6.7 million in currency into the banking system. Other things equal, what must the Bank of Canada do to bank reserves to keep the money supply the same?
A)reduce reserves by $6.7 million
B)reduce reserves by $5 million
C)increase reserves by $3 million
D)No action by the Bank of Canada is necessary.

Question

Quizplus · Accepted Answer

The public's decision to deposit more currency into the banking system increases the money supply. To keep the money supply the same, the Bank of Canada must reduce reserves by the same amount, which is $6.7 million.

The Banking System Has $20 Million in Reserves and Has