Question

Suppose that the Fed has set the reserve ratio at 10 percent and that banks collectively have \(2 billion in excess reserves. What is the maximum amount of new checkable-deposit money that can be created by the banking system?

1. \)0

2. \(200 million

3. \)2 billion

4. $20 billion

Short answer

Option (d) $20 billion

Step-by-step solution

Meaning of new checkable-deposit money

The new checkable-deposit money is the increase in money supply by the circulation of excess reserves. The excess reserve creates the new checkable-deposit money by the rate of a monetary multiplier.

New Checkable-Deposit Money=ExcessReserve x Monetary Multiplier

D = E x m

The monetary multiplier is expressed as the inverse of the required reserve ratio.

$$\begin{gathered} MonetaryMultiplier=\frac{1}{RequiredReserveRatio} \\ m=\frac{1}{R} \end{gathered}$$

Calculations for the answer

Given that R = 0.1 ( or 10%), the monetary multiplier is:

$m=\frac{1}{0.1}=10$

Since excess reserves are $2 billion, the new checkable-deposit money is:

D = $ 2 billion x 10

= $ 20 billion

Hence, the answer is $20 billion.