Assume that Jill deposits $20,000 in cash into her checking account at Welcome National Bank and the central bank has set a required reserve ratio of 10%.

A. Explain the immediate effect of her deposit on the M1 measure of the money supply.

B. If Welcome National Bank holds an additional 10% of her deposit in reserves, calculate the following:

-the maximum amount the bank will loan out

-the maximum increase in the money supply as a result of this transaction

M1 is reserves which can easily be converted to cash. Such amounts should always be reserved as liquid in the banks.

A. The deposit of $20,000 increases M1 by 10% of the amount deposited. That is,

M1 increase = 0.1*20,000 = $2,000.

B. Part 1

Amount to be loaned out = Deposit - (Total reserve*Deposit) = 20,000 - [ (2*0.1) * 20,000] = 20,000 - 4,000 = $16,000

B. Part 2

Increase in money supply = 20% of deposit - 10% of deposits = Deposit (20%-10%) = 20,000 (0.2 - 0.1) = 20,000 (0.1) = $2,000