AP Macroeconomics 4.4: Banking and Money Supply

Analyze fractional-reserve banking, required and excess reserves, bank lending, and the maximum money-supply expansion from deposits.

Covered syllabus points

POL-2.A—a. Define key terms related to the banking system and the expansion of the money supply. b. Explain how the banking system creates…

[Maximum number: 1]

Assume that commercial banks must hold a minimum of 20% of their deposits as reserves. Now suppose that the central bank of the country sells $100,000 of government bonds to commercial banks.

Calculate the maximum change and state the direction of change in the money supply as a result of the central bank bond sale. Show your work.

Calculate the maximum change in the money supply as a decrease of $500,000 and show your work.

\begin{aligned} \text { Change in MS } & =\text { Bond Sale } \text { × } \text { Money Multiplier }=-\$ 100,000 \times \frac{1}{0.2} \\ & =-\$ 500,000 \end{aligned}

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Covered syllabus points

4.4 Banking and the Expansion of the Money Supply question 1