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Chapter 14: Q. 27 (page 353)

Explain what will happen to the money multiplier

process if there is an increase in the reserve

requirement?

Short Answer

Expert verified

On the contrary, the money supply increases when the reserve requirement is lower.

Step by step solution

01

Concept Introduction

The amount of cash that the bank generates with each reserve is called the money multiplier. Taking in the deposits, keeping in the reserves and lending out the rest leads to the increasing amount of money in the money supply. Reserve requirement is the ratio that shows the amount of deposit that the bank must hold and that amount is not lent out.

02

Explanation of Solution

When the reserve requirement increases, the money supply tightens which leads to a lower multiplier effect. This results in bank to lend out less because the option will have some limitation based on the size of the reserve. The money supply increases when the reserve requirement is lower.

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Most popular questions from this chapter

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Humongous Bank is the only bank in the economy. The people in this economy have 20\(million in money, and they deposit all their money in Humongous Bank.

a. Humongous Bank decides on a policy of holding\)100reserves. Draw a T-account for the bank.

b. Humongous Bank is required to hold \(5%of its existing\)20million as reserves, and to loan out the rest. Draw a T-account for the bank after it has made its first round of loans.

C. Assume that Humongous bank is part of a multibank system. How much will money supply increase with that original$19million loan?
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