Question

Suppose the nation's Central Bank (CB) decides to engineer an increase in the nation's money supply, and begins the process with an open market operation (OMO), in which the CB purchases 2000+ worth of Treasury securities from Household j (HH). HHJ deposits the entire 2,000€ in cash into a demand deposit account at Bank A. The CB has set the reserve requirement ratio (ra) at 40%. The maximum possible deposit expansion that results from the initial increase in total bank reserves of 2,000 £ in cash, is equal to: A) 1,000 € OB) 4,000 $ $ 35 § 38 g 2,000 € D) 5,000 € E) 3,000 €

Answer 1

D) 5000

​​​​​​Deposit multiplier = (1/r_{​​​​​​d})

r_{​​​​​​d} = 40% = 0.4

So, deposit multiplier = 1/0.4 = 2.5.

The maximum possible deposit expansion is the product of deposit multiplier and the amount of deposits.

The amount of deposits is given as 2000.

So, the maximum deposit expansion = 2.5*2000 = 5000.

So, the maximum deposit expansion resulting from initial increase in bank reserves (2000) is 5000.