Question

1. Assume that the reserve ratio in a country is 2%.

1. Use a formula to calculate the simple money multiplier, show all steps involved in the calculation.
2. Suppose that in 2019 customers deposit $200 into their banks. Based on the simple money multiplier calculated in part (i), calculate the total amount which the money supply in the banking system will eventually increase to. Show all steps involved in the calculation.   
3. Assume the amount of funds deposited by customers in 2020 stands at $400. and the reserve ratio increases to 8%. Will the money supply in the banking system increase, decrease or stay the same from 2019 levels? If it increases or decreases, calculate by how much it will change. If it stays the same, explain why. Show all steps involved in any calculations.

Answer 1

i) Money multiplier

ii) Initial deposit = $200

Multiplier = 50

Thus,

= 50 (200)

= $10,000

The eventual increase in money supply will be $10,000.

iii) If r = 8%,

Money multiplier

Initial deposit = $400

Multiplier = 12.5

Thus,

= 12.5 (400)

= $5,000

The eventual increase in money supply will be $5,000.

The money supply changes by a lesser extent in 2020, compared to 2019.

In 2019, MS increased by $10,000. In 2020, MS increased by $5,000.

Reasons

In 2019, the multiplier was 50. In 2020, it is 12.5. Thus, it has reduced to 1/4th of the value of 2019.

In 2019, the deposits were $200, and in 2020 they were $400. Thus, they have doubled.

The net effective change in Money Supply is (-1/4) X 2 = (-1/2)

Thus, inspite of doubling of the deposit, the overall change in money supply is a reduction to half of its original value.