Suppose that the required reserve ratio is 10 percent and you withdraw $25,000 from Comerica Bank. What is the deposit multiplier? What is the total decrease in deposits in the banking system? What is the change in the money supply?
What will be an ideal response?
The simple deposit multiplier is equal to (1/required reserve ratio). In this case it is 1/0.1 = 10. Since the deposit multiplier is 10, then a decrease in deposits in the banking system is equal to the multiplier times the initial withdrawal. The change in deposits will be negative as the withdrawal will shrink deposits in the banking system. This is 10 × -$25,000 = -$250,000. To find the change in the money supply, we must then add back the initial withdrawal, as now cash held by the public increases by the size of the initial withdrawal. Thus the change in the money supply is -$250,000 + $25,000 = -$225,000.
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