Question

The following information describes a hypothetical economy that has a single commercial bank.

The ratio of currency to deposits is zero.

The money multiplier is 5.

The bank has excess reserves of R120 and Loans of R180.

Its balance sheet consists only of reserves, loans and deposits.

Which of the following statements is/are correct?

The required reserve ratio is 5%

The value of deposited funds is currently R300.

The maximum additional amount the banking system as a whole can create is R600.

A. Only (i) is correct.

B. Only (iii) is correct.

C. Only (ii) is correct.

D. Only (ii) and (iii) are correct.

Answer 1

Money multiplier = 5

Money multiplier = 1/Required reserve ratio

5 = 1/Required reserve ratio

Required reserve ratio = 1/5 = 0.20 or 20%

Thus, the required reserve ratio is 20%.

The bank has excess reserves of R120 and loans of R180.

The balancesheet consists only of reserves, loans and deposits.

So,

Deposits would be equal to sum of the reserves and loans.

Reserves include both required reserves and excess reserves.

However, the sum of excess reserves and loans is (R120 + R180) R300. If we add required reserves to this then the value of the deposits would be greater than R300.

Calculate the maximum additional amount the banking system as a whole can create -

Maximum additional amount = Excess reserves * Money multiplier

Maximum amount = R120 * 5 = R600

Thus,

The maximum additional amount the banking system as a whole can create is R600.

Hence, the correct answer is the option (B) [Only (iii) is correct].