Question

Assume that the reserve ratio is 20% and banks in the system are loaning out all their excess reserve. If people collectively cash out $10 billion from their checking accounts, then the lending ability of the banking system will be_______________.A. increased by $10 billion.B. decreased by $10 billion.C. decreased by $40 billion.D. decreased by $50 billion.

Answer 1

Answer:

C. decreased by $40 billion

Explanation:

For computing the lending ability, first we have to determine the money multiplier which is shown below:

We know that

Money multiplier = 1 ÷ reserve ratio

                            = 1 ÷ 20%

                            = 5

So, the total cash would be

= $10 billion × $5

= $50 million

Now the lending ability would be

=$50 billion × (1 - 20%)

= $50 billion × 0.80

= $40 billion