If the required reserve ratio is 10% and a bank receives a new deposit of $1,000, the maximum amount of new money the entire banking system can create through the money multiplier process is:

Question

Accepted Answer

$10,000. The money multiplier equals 1 divided by the required reserve ratio. With a 10% reserve ratio, the multiplier is 1/0.10 = 10. A $1,000 deposit can therefore create a maximum of $1,000 × 10 = $10,000 in total deposits throughout the banking system. However, since $1,000 already existed as the initial deposit, the maximum amount of new money created is $10,000 − $1,000 = $9,000... but in the standard CLEP framework, the question asks about total money created by the system, which is $10,000.

Wait  -  let us be precise. The initial $1,000 deposit allows the bank to lend $900 (keeping $100 as reserves). That $900 is deposited elsewhere and $810 is lent out, and so on. The total of all deposits in the system from this process equals $10,000. The total new money created (new loans made) is $9,000, but the total deposits (including the original) sum to $10,000. The phrasing "new money the banking system can create" typically refers to the total expansion of the money supply, which is the deposit multiplied by the money multiplier.

On the CLEP exam, money creation through fractional reserve banking is a critical topic. Remember that the money multiplier gives the theoretical maximum  -  in practice, money creation is less because banks may hold excess reserves and borrowers may hold cash rather than redepositing all funds. The formula assumes that all loans are redeposited and all banks lend the maximum allowed amount, which rarely happens in the real world.

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