Suppose that there are no excess reserves in the banking system and the current

Question

Suppose that there are no excess reserves in the banking system and the current amount of checkable deposits are equal to $100,000. Now the monetary authorities raise the required reserve ratio from 5% to 10%. Which of the following will likely follow? The amount of excess reserves in the banking system will rise. The amount of excess reserves in the banking system will remain the same. The money creating potential of the banking system will decline. The money creating potential of the banking system will rise.

Explanation / Answer

Answer: The money creating potential of the banking system will decline.

Reason: As reserve ratio increases, more reserves need to be maintained and hence, lower loans can be given out, resulting in less money creation facility.

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