Question

Assume that a single commercial bank has no excess reserves and that the reserve ratio is 20 percent. If this bank sells a bond for $1,000 to a Federal Reserve Bank, it can expand its loans by a maximum of:_________
A. $1,000.
B. $2,000.
C. $800.
D. $5,000.

Answer 1

Answer:

D) $5,000.

Explanation:

The money multiplier will determine the bank's capacity to "create" money.

The money multiplier = 1 / reserve ratio = 1 / 20% = 5

If the bank sells a $1,000 bond, it will expand its total loans by the increase in the reserves x the money multiplier = $1,000 x 5 = $5,000