Question

FILL IN THE BLANK. Answer the next question on the basis of the following consolidated balance sheet of the commercial banking system. Assume that the reserve requirement is 20%. All figures are in billions. If the Fed reduced the reserve requirement from 20% to 16%, excess reserves in the commercial banking system would increase ____ by and the monetary multiplier would rise to ____

Answer 1

If the Fed reduced the reserve requirement from 20% to 16%, excess reserves in the commercial banking system would increase by $40 billion and the monetary multiplier would rise to 6.25

When the Fed reduces the reserve ratio, it then lowers the amount of cash which the banks are required in order to hold in reserves, by allowing them to make more loans to consumers and businesses. Thus, this increases the nation's money supply and also expands the economy.

So suppose if the required reserve ratio is 20%, the deposit multiplier is five. Which means that for every $1 the commercial banking system has in reserves, by which it can increase the money supply by up to $5.

Hence, the Fed reduced the reserve requirement from 20% to 16%.

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