Question

If all the banks in the banking system collectively have $500 million in cash reserves, and have a target reserve ratio of 5%, the maximum amount of deposits the banking system can support is

A) $10 million.
B) $100 million.
C) $25 billion.
D) $100 billion.
E) $10 billion.

Answer 1

The maximum amount of deposits the banking system can support is $10 billion.

Step-by-step explanation:

To calculate the maximum amount of deposits the banking system can support, we need to use the formula for the money multiplier:

Money Multiplier = 1 / Reserve Ratio

Given that the target reserve ratio is 5%, the money multiplier is 1 / 0.05 = 20.

To find the maximum amount of deposits, we multiply the cash reserves by the money multiplier:

Maximum Deposits = Cash Reserves × Money Multiplier = $500 million × 20 = $10 billion.

Therefore, the maximum amount of deposits the banking system can support is $10 billion (Option E).