ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -If the reserve requirement is 10%, the deposit multiplier means that banks must keep 10% of all deposits in reserve, but they can create money and stimulate economic activity by lending out the other 90%. So, if someone deposits $100, the bank must keep $10 in reserve but can lend out $90.

Detailed explanation-2: -These changes can lead to increase in money supply. For example, assume the entire banking system has $1000 in deposits and the required reserve ratio is 10% and banks are fully loaned up. That means the total reserve in the banking system is $100.

Detailed explanation-3: -This practice enables banks to hold only a fraction of all deposits as reserves that are available for withdrawals. Banks use the remaining fraction of deposits to make new loans; charging interest on those loans.

Detailed explanation-4: -If the reserve ratio was 10%, the deposit multiplier would be 10, and the bank could increase the money supply by $10 for every $1 in reserves. In essence, the lower a bank’s required reserve ratio, the higher the deposit multiplier will be and the more money it can lend out to customers.

Detailed explanation-5: -The Federal Reserve requires banks and other depository institutions to hold a minimum level of reserves against their liabilities. Currently, the marginal reserve requirement equals 10 percent of a bank’s demand and checking deposits.