Answer:
Maximum expansion in money supply = $5,000
Explanation:
The fractional banking system requires banks to keep a percentage of their total deposit as reserve and lend the rest as loans and advances
The total maximum amount that can be created by the bank is equal TO the amount of deposit multiplied by the creation multiplier.
The multiplier = 1/reserve ratio
Maximum amount = 1,000 × 1/0.2
= $5,000
The maximum possible expansion that could be seen in money supply by using initial deposits would be $5,000.
The reserve requirement is given as 20% or 0.20 and $1,000 as initial deposits.
The computation of money supply expansion is determined with the help of a money multiplier, which is given below:
[tex]k=\frac{1}{RR}\\=\frac{1}{0.20} \\=5[/tex]
Here, k is the money multiplier and RR is the reserve ratio.
Hence, the final increase in the money supply would be derived by multiplying the value of multiplier with initial deposits, that is:
[tex]5*1000\\=5000[/tex]
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