What will happen to the money supply under the following circumstances in a chec

Question

What will happen to the money supply under the following circumstances in a checkable-deposit-only system? The required reserve ratio is 25%, and a depositor withdraws $700 from this checkable bank deposit. The required reserve ratio is 5%, and a depositor withdraws $700 from this checkable bank deposit. The required reserve ratio is 20%, and a depositor deposits $750 from this checkable bank deposit. The required reserve ratio is 10%, and a depositor deposits $750 from this checkable bank deposit.

Explanation / Answer

(a) Money Multiplier = 1 /0.25 = 4.

Deposits reduce by $2,800 (i.e. 4 * $700) but $700 is converted into currency held by the public. The money supply contracts by $2,100 (i.e. $2800 - $700).

(b) Money Multiplier = 1 /0.05 = 20.

Deposits reduce by $14,000 (i.e. 20 * $700) but $700 is converted into currency held by the public. The money supply contracts by $13,300 (i.e. $14,000 - $700).

(c) Money Multiplier = 1 /0.20 = 5.

Deposits increase by $3,750 (i.e. 5 * $750) but currency in circulation falls by $750. The money supply expands by $3,000 (i.e. $3,750 - $750).

(d) Money Multiplier = 1 /0.10 = 10.

Deposits increase by $7,500 (i.e. 10 * $750) but currency in circulation falls by $750. The money supply expands by $6,750 (i.e. $7,500 - $750).

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