Suppose the State Bank purchases a Rs 1,000 government bond from you. If you deposit the entire Rs 1,000 in you bank what is the total potential change in the money supply as a result of the State Bank's action if the your bank's reserve ratio is 20 percent ?
Correct answer: B. Rs 5,000
- A. Rs 4,000
- B. Rs 5,000
- C. Rs 1,000
- D. Rs 0
Explanation
With a 20 percent reserve ratio, the simple deposit multiplier is 1/0.20 = 5. A Rs 1,000 reserve injection can therefore support a maximum total increase of Rs 5,000 in deposits and money supply.
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