Question

Suppose you have $8000 in your checking account. You withdraw $500 cash from your account and hide it under your pillow for future use. If the required reserve ratio is 10%, then what will be the maximum impact on money supply today as a result of your action?

Answer 1

Answer:

The money supply decreases by $4,500.

Explanation:

The amount of deposits is $8,000.

The required reserve ratio is 10%.

The amount of required reserve

= 10% of $8,000

= $\frac{10}{100}\times 8,000$

= $800

The amount to be loaned out

= Total deposit - Required reserves

= $8,000 - $800

= $7,200

The money supply is equal to money multiplier times the monetary base.

Money supply

= $\frac{1}{RR} \times Monetary\ base$

= $\frac{1}{0.1}\times \ 7,200$

= $72,000

So, the money supply before withdrawal is $72,000.

After withdrawal of $500, the deposits is

= $8,000 - $500

= $7,500

The amount of required reserve

= 10% of $7,500

= $\frac{10}{100}\times 7,500$

= $750

The amount to be loaned out

= Total deposit - Required reserves

= $7,500 - $750

= $6,750

Money supply

= $\frac{1}{RR} \times Monetary\ base$

= $\frac{1}{0.1}\times \ 6,750$

= $67,500

So, the money supply after withdrawal is $67,500.

The decrease in money supply

= $75,000 - $67,500

= $4,500