Reserve Requirement and Money Deposit Expansion Multiplier

A

The potential money deposit expansion multiplier is calculated by taking the inverse of the reserve requirement ratio. This is: 1/.125 = 8.

The money deposit expansion multiplier, also known as the deposit multiplier or the money multiplier, is a concept used to determine the potential increase in the money supply through the fractional reserve banking system. It represents the maximum amount of new money that can be created by banks through the process of deposit creation.

To calculate the money deposit expansion multiplier, we need to use the reserve requirement. The reserve requirement is the percentage of deposits that banks are required to hold in reserve and not lend out. In this case, the reserve requirement is given as 12.5 percent.

The formula for calculating the money deposit expansion multiplier is:

Money Deposit Expansion Multiplier = 1 / Reserve Requirement

Using the given reserve requirement of 12.5 percent, we can calculate the money deposit expansion multiplier as follows:

Money Deposit Expansion Multiplier = 1 / 0.125

Money Deposit Expansion Multiplier = 8

Therefore, the correct answer is A. 8.

The money deposit expansion multiplier of 8 implies that for every unit of reserves held by the banks, they can create up to 8 units of new money through the lending process. This expansion of the money supply is a result of the fractional reserve banking system, where banks are only required to keep a fraction of the deposits as reserves and can lend out the remaining funds.