Question

Assume that the banking system has total reserves of $200 billion. Additionally, assume that the Federal Reserve mandates that required reserves are 25% of checking deposits. Banks may not hold excess reserve and households have no currency. What is the money supply?

Select one:

a. $600 billion

b. $450 billion

c. $800 billion

d. $300 billion

Answer 1

A cash reserve ratio is usually a mandate of the federal bank to retain some of the banks money so as to regulate the flow of capital in the economy. This makes the banks more responsible in granting loans to others and the economy is safeguarded from major shocks as the federal bank has sufficient reserves to replicate if need be. It is also used to vary interest rates in the market from time to time respectively.

If 25% of the total money is in the form of reserves then out of the available options, 25% amount should be equal to 200 Million $ this happens because, out of the total availability some amount is charged by the reserve bank as a deposit to keep interest rates normal.

This is also at times referred to as cash deposit ratio in most cases. The above example can easily be solved by analyzing what 25% of each of the amounts stated is.

(A) 25% of 600 Billion is 150 Billion as calculated by 25/100*600$Billion but the current reserves indicate a reserve of 200 Billion $ thus Option A is false

(B)  25% of 450 Billion is 112.5 Billion as calculated by 25/100*450 Billion $ but the current reserves indicate a reserve of 200 Billion $ thus Option B is false

(C) 25% of 800 Billion is 200 Billion as calculated by 25/100*800 Billion $ and the current figures represent a reserve of 200 Billion $ thus Option C is True

(D)  25% of 300 Billion is 75 Billion as calculated by 25/100*300 Billion $ and the current figures represent a reserve of 75 Billion $ thus Option D is False

Therefore, the correct answer to the question is option C

Please feel free to ask your doubts in the comments section.