CFA Level 1: Excess Reserves and Loan Potential

Excess Reserves and Loan Potential

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On a certain date, the banking system had $2 billion in excess reserves. The legally required reserve ratio was 12.5 percent. Potentially, the banking system as a whole could increase its loans a maximum of

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A. B. C. D.

D

The deposit expansion multiplier in this economy is 8 (found by taking the inverse of 12.5%=1/(.125)). Since banks hold an excess $2 billion in reserves they could extend loans in this amount and increase the money supply by 8 x $2 billion = $16 billion.

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