Assume that the banking system initially has total reserves of €1000 billion, wh

Question

Assume that the banking system initially has total reserves of €1000 billion, while the reserve requirement is equal to 10%. Assume also that banks hold no excess reserves and households hold no currency. What would happen with total reserves in the economy and the total amount of money in the economy if the reserve requirement would increase to 20%? A) The amount of money would decrease by 10%, while the amount of reserves would increase by 100%. B) The amount of money would decrease by 10%, while the amount of reserves would remain the same. C) The amount of money would decrease by 50%, while the amount of reserves would increase by 100%. D) The amount of money would decrease by 50%, while the amount of reserves would remain the same.

Explanation / Answer

And: The amount of money would decrease by 50%, while the amount of reserves would increase by 100%.

Explanation:

When reserve ratio is 10%:

Reserve amount = $1000 * 0.10 = $100

Money multplier = 1 / RR = 1/ 0.10 = 10

Total amount of money in the banking system = $1000 * 10 = $10,000.

When Reserve ratio is 20%:

Reserve amount = $1000 * 0.20 = $200

So, reserves increase by 100%

Money multplier = 1 / 0.20 = 5

Total amount of money in the banking system = $10,000 * 5 = $5,000

So, the amount of money decreases by 50%.

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