Question

Suppose that the value of the potential money multiplier is equal to 4 . What is the reserve ratio?

Short answer

As a result, the reserve ratio $0.25$ or$25\%$

Step-by-step solution

Definition of reserve ratio

The reserve ratio is the percentage of reservable liabilities that commercial banks must keep rather than investing or lending. It is an essential instrument of monetary policy in an economy, and it helps to regulate the money supply. When the central bank wishes to expand the money supply of the economy, it reduces the reserve ratio. The commercial banks would thus have more cash to lend out.

Step2:Find reserve ratio

The following expression can be used to calculate the reserve ratio:

Potential money multiplier$=\left(\frac{1}{\text{reserveratio}}\right)$

Given: Potential money multiplier is $4.$

Substituting the value in the preceding expression yields:

$4=\left(\frac{1}{\text{Reserve ratio}}\right)$

Reserve ratio $=\frac{1}{4}$

$=0.25$

As a result, the reserve ratio$0.25$or $25\%$