Here is a first-year macroeconomics question: Suppose that the Bank of Canada\'s

Question

Here is a first-year macroeconomics question:

Suppose that the Bank of Canada's issue of legal tender (currency) is $27 billion, currency in circulation is $21 billion, and the target reserve ratio is 8% (0.08). Which of the following is true at equilibrium?

a) Reserves are $2.16 billion and Loans are $24.82 billion

b) Deposits are $48 billion and Loans are $42 billion

c) Deposits are $62.5 billion and Money Supply is $83.5 billion

d) Loans are $69 billion and Money Supply is $90 billion

e) Deposits are $75 billion and Money Supply is $96 billion

Explanation / Answer

As the currency in circulation is $21 billion from total of $27 billion that is isuued by Bank of Canada's

It means the deposits in the bank is $27 billion - $21 billion = $6 billion.

The target reserve ratio is 8% (0.08) so the reserves in the banks will be 8% of $6 billion.

Reserves = $6 billion * 0.08 = 0.48 billion

After keeping the required reserves banks are free to lend the amount of $6 billion - $0.48 billion = $5.52 billion.

Multiplier is 1/ reserve ratio = 1/0.08 = 12.5

so total amount of deposits in the form of loans are 5.52 billion * 12.5 = $69 billion

and total money supply in Canada = Currency in circulation + Total amount of money deposited in the account Canadian's in the form of loan.

Total money supply = $21 billion + $69 billion = $90 billion.

so correct option is d)

other option is incorrect because

option a) does not take the multiplier effect.

option b) are incorrect because Loans are $69 billion an deposits are not $48 billion.

option c) is incorrect because money supply is $90 billion and deposits are not $62.5billion.

option e) is incorrect because it also does not take the reserve ratio in consideraton.

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