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2 May, 12:17

Suppose you have $12000 in your checking account. You withdraw $500 cash from your account and hide it under your pillow for future use. If the required reserve ratio is 10%, then what will be the maximum impact on money supply today as a result of your action?

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  1. 2 May, 13:34
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    money supply decreases by $4,500

    Explanation:

    Money multiplier (m) = 1 : Reserve required ratio

    = 1 : 0.1

    = 10

    Initial amount of deposits = $12,000

    Required reserves = 10% of $12,000

    = $1,200

    Therefore,

    Amount that is loaned out by bank = $12,000 - $1,200

    = $10,800 (Monetary base)

    Hence, the money supply before the withdrawal is as follows:

    = Money multiplier * Monetary base

    = 10 * $10,800

    = $108,000

    When $500 cash withdraw from the bank account:

    The amount of deposits reduce to $11,500

    Required reserves = 10% of $11,500

    = $1,150

    Therefore,

    Amount that is loaned out by bank = $11,500 - $1,150

    = $10,350 (Monetary base)

    Hence, the money supply before the withdrawal is as follows:

    = Money multiplier * Monetary base

    = 10 * $10,350

    = $103,500

    Reduction in the money supply:

    = $108,000 - $103,500

    = $4,500

    Therefore, the money supply decreases by $4,500.
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