In the country of Azeroth, people hold as much currency as they have on their bank....

In the country of Azeroth, people hold as much currency as they have on their bank. If banks lend out all of the deposits, what is the money multiplier? Note: Make sure to write your answer out as a number.

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Expert Solution

Bank creates money through lending process. Assume an initial deposit of $10,000 is made and required reserve ratio is 10%.

Money Multiplier = (1 / Required Reserve ratio) = (1 / 0.1) = 10. Bank can raise money supply by maximum of 10 * 10,000 = 100,000

It means that bank keep 10% of 10,000 with them and lend rest of the money which is $9,000 in its first round. They assume that this $9,000 will come back to them when people spend money in the market. If people hold currency and deposit half in the bank which will result in fall in deposit money received by banks. In earlier situation bank will get back $9,000 and they will lend $8,100 by keeping 10% with them in second round of lending while if people hold cash, bank will not get $9,000 in return and bank would not be in a situation to lend more money. It will result in fall in money multiplier in the economy and eventually the maximum amount of money supply.

Rahul Sunny answered 1 year ago

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