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Required Reserves and the Deposit Multiplier quiz

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  • What is the reserve ratio in banking?
    The reserve ratio is the fraction of deposits that banks are required to keep as reserves, usually mandated by the government.
  • In a 100% reserve banking system, what happens to all deposits?
    All deposits are held as reserves, so the reserve ratio is 1 and no money is loaned out.
  • What is fractional reserve banking?
    Fractional reserve banking is a system where banks keep only a portion of deposits as reserves and loan out the rest.
  • How do required reserves differ from excess reserves?
    Required reserves are the minimum reserves a bank must hold by law, while excess reserves are any reserves held above this requirement.
  • What is the money multiplier?
    The money multiplier is the amount of money the banking system generates with each dollar of reserves, calculated as 1 divided by the reserve ratio.
  • How does a lower reserve ratio affect the money multiplier?
    A lower reserve ratio increases the money multiplier, allowing more money to be created from the same initial deposit.
  • If the reserve ratio is 10%, what is the money multiplier?
    The money multiplier is 10, because 1 divided by 0.10 equals 10.
  • What happens to the money supply when banks loan out excess reserves?
    The money supply increases because the loaned money is deposited and re-loaned multiple times, multiplying the initial deposit.
  • In the example, what was the total increase in the money supply from a \$1,000 deposit with a 10% reserve ratio?
    The total increase in the money supply was \$10,000.
  • Why does the money supply keep growing with each round of loans and deposits?
    Because each loan becomes a new deposit, which can then be partially loaned out again, continuing the cycle.
  • What is included in the M1 definition of money supply?
    M1 includes currency in circulation and checking account deposits.
  • What happens to currency in circulation when all money is deposited in banks?
    Currency in circulation drops to zero, but deposits in banks increase by the same amount.
  • How does the reserve requirement set by the government impact bank lending?
    A higher reserve requirement means banks must hold more reserves and can loan out less, reducing the money multiplier.
  • What is the formula for the reserve ratio?
    The reserve ratio is calculated as reserves divided by deposits.
  • Why is the process of money creation in banks described as a multiplier effect?
    Because each deposit leads to multiple rounds of lending and depositing, greatly increasing the total money supply from the initial deposit.