The central bank of Albernia likes to use changes in the reserve requirement to manage the money supply. The commercial banks of Albernia have $100 million in reserves and $1,000 million in deposits, the initial required reserve ratio is 10%. (The commercial banks follow a policy of holding no excess reserves). How much, at most, will the money supply change if the required reserve ratio falls to 5%?

$10,000 million

Explanation:

The computation of  the change in the money supply is shown below:

At 10%

Required reserves= deposits × required reserve ratio

= $1000 million × 10%

= $100 million

Now

The total amount of money supply is

New deposits= 1 ÷ required rate of return  x deposits

= 1 ÷ 10% × $1000 million  

= 10 x $1000

= $10,000 million

At 5%

As we know that

Required reserves= deposits × required reserve ratio

= $1000 million × 5%

= $50 million

Now

The total amount of money supply is

New deposits= 1 ÷ required rate of return  x deposits

= 1 ÷ 5% × $1000 million  

= 20 x $1000

= $20,000 million

Now change in supply is

= $20,000 million -$10,000 million

= $10,000 million

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