Question

Suppose the reserve ratio is 0.25, and the Bank of Canada buys $2,000 of Canadian government securities. What is the minimum amount by which the money supply can increase? A) $4,000 B) $3,000 C) $8,000 D) $2,000

Answer 1

Reseve ratio= 0.25

Bank of canada buys $2000 of Canadian government securities.

This will cause intially the money supply to increase by $2000.

Maximum rise in money supply= $2000 x 1/0.25= $2000 x 4= $8000

It means that if bank keep only 25% of total deposit as a reserve then it can cause maximum increase in money supply by $8000.

Now if banks keep all the amount as reserve and not provide anything further as a loan and it will cause no money creation by the banks. So this will cause no increase in money supply further.

The minimum amount by which money supply can increase is $2000.

D) is the correct option.