{"id":22055,"date":"2025-06-16T09:13:07","date_gmt":"2025-06-16T09:13:07","guid":{"rendered":"https:\/\/gaviki.com\/blog\/?p=22055"},"modified":"2025-06-16T09:13:11","modified_gmt":"2025-06-16T09:13:11","slug":"if-banks-reduce-their-excess-reserves-by-1m","status":"publish","type":"post","link":"https:\/\/gaviki.com\/blog\/if-banks-reduce-their-excess-reserves-by-1m\/","title":{"rendered":"If banks reduce their excess reserves by $1m"},"content":{"rendered":"\n<p>If banks reduce their excess reserves by $1m, what will happen to the money supply (assume a reserve requirement of 2%, c = 0 and e = 0)? Group of answer choices it will increase by $100m it will decrease by $100 m it will increase by $50m it will decrease by $5m<\/p>\n\n\n\n<p><mark style=\"background-color:rgba(0, 0, 0, 0)\" class=\"has-inline-color has-vivid-cyan-blue-color\"><strong>The correct answer and explanation is:<\/strong><\/mark><\/p>\n\n\n\n<p><strong>Correct Answer: It will increase by $50 million<\/strong><\/p>\n\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<h3 class=\"wp-block-heading\"><strong>Explanation:<\/strong><\/h3>\n\n\n\n<p>To understand how a $1 million reduction in <strong>excess reserves<\/strong> affects the <strong>money supply<\/strong>, we use the concept of the <strong>money multiplier<\/strong> in the banking system.<\/p>\n\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<h3 class=\"wp-block-heading\"><strong>Key Terms:<\/strong><\/h3>\n\n\n\n<ul class=\"wp-block-list\">\n<li><strong>Reserve Requirement (rr):<\/strong> This is the fraction of deposits that banks must keep as reserves. In this question, it&#8217;s 2% or 0.02.<\/li>\n\n\n\n<li><strong>Excess Reserves:<\/strong> Money that banks hold beyond what is required. If banks reduce this by $1 million, they are <strong>lending it out<\/strong>, which increases the money supply.<\/li>\n\n\n\n<li><strong>Currency-deposit ratio (c):<\/strong> This is 0, meaning all money is held in bank deposits.<\/li>\n\n\n\n<li><strong>Excess reserve ratio (e):<\/strong> This is also 0, meaning banks do not hold any extra reserves beyond the required minimum.<\/li>\n\n\n\n<li><strong>Money Multiplier (m):<\/strong> m=1rr+e+c=10.02+0+0=10.02=50m = \\frac{1}{rr + e + c} = \\frac{1}{0.02 + 0 + 0} = \\frac{1}{0.02} = 50<\/li>\n<\/ul>\n\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<h3 class=\"wp-block-heading\"><strong>Step-by-Step Calculation:<\/strong><\/h3>\n\n\n\n<ol class=\"wp-block-list\">\n<li><strong>Reduction in excess reserves<\/strong> = $1,000,000<\/li>\n\n\n\n<li><strong>Money multiplier<\/strong> = 50<\/li>\n\n\n\n<li><strong>Increase in money supply<\/strong> = 1,000,000 \u00d7 50 = <strong>$50,000,000<\/strong><\/li>\n<\/ol>\n\n\n\n<hr class=\"wp-block-separator has-alpha-channel-opacity\"\/>\n\n\n\n<h3 class=\"wp-block-heading\"><strong>Conclusion:<\/strong><\/h3>\n\n\n\n<p>If banks reduce their excess reserves by $1 million and lend it out, the banking system multiplies this base money through the process of deposits and loans. With a reserve requirement of 2% and no currency or excess reserves held back, the entire $1 million gets multiplied by 50, increasing the <strong>money supply by $50 million<\/strong>.<\/p>\n\n\n\n<p>Thus, <strong>the correct answer is: &#8220;It will increase by $50 million.&#8221;<\/strong><\/p>\n","protected":false},"excerpt":{"rendered":"<p>If banks reduce their excess reserves by $1m, what will happen to the money supply (assume a reserve requirement of 2%, c = 0 and e = 0)? Group of answer choices it will increase by $100m it will decrease by $100 m it will increase by $50m it will decrease by $5m The correct [&hellip;]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[1],"tags":[],"class_list":["post-22055","post","type-post","status-publish","format-standard","hentry","category-quiz-questions"],"_links":{"self":[{"href":"https:\/\/gaviki.com\/blog\/wp-json\/wp\/v2\/posts\/22055","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/gaviki.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/gaviki.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/gaviki.com\/blog\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/gaviki.com\/blog\/wp-json\/wp\/v2\/comments?post=22055"}],"version-history":[{"count":1,"href":"https:\/\/gaviki.com\/blog\/wp-json\/wp\/v2\/posts\/22055\/revisions"}],"predecessor-version":[{"id":22056,"href":"https:\/\/gaviki.com\/blog\/wp-json\/wp\/v2\/posts\/22055\/revisions\/22056"}],"wp:attachment":[{"href":"https:\/\/gaviki.com\/blog\/wp-json\/wp\/v2\/media?parent=22055"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/gaviki.com\/blog\/wp-json\/wp\/v2\/categories?post=22055"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/gaviki.com\/blog\/wp-json\/wp\/v2\/tags?post=22055"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}