Suppose \(\$ 100\) is deposited into a bank. If the required reserve ratio is \(100 \%\), what is the demand deposit multiplier and what is the total addition to demand deposits of the banking system resulting from the initial deposit?

The required reserve ratio is a pivotal regulation in the banking industry, dictating the minimum fraction of customers' deposits that a bank must keep on hand as reserves. This ratio acts as a safeguard for the deposits, ensuring that banks have enough funds to meet their customers' immediate withdrawal demands and maintain stability in the financial system.

For instance, a higher required reserve ratio, such as 100%, means that a bank cannot lend out any of the deposited funds, restricting the creation of additional money through the lending process. Conversely, a lower reserve ratio allows banks to lend more, which generally increases the money supply in the economy as the same unit of currency is used to create multiple loans. Understanding this concept is crucial for grasping how banks contribute to the expansion or contraction of the money supply.

The money supply in the banking system refers to the total amount of money available within the economy, which includes cash, coins, and balances held in checking and savings accounts. Banks play a significant role in adjusting this supply through their lending activities.

When a bank receives a deposit, it can lend a portion of this deposit to others, who in turn can deposit their loan receipts in the banking system. This process creates a multiplicative effect on the money supply known as the money multiplier effect. However, the extent of this impact is contingent on the required reserve ratio mentioned earlier. If the reserve ratio is set high, such as in the given example of a 100% ratio, the money multiplier is neutered, and banks do not increase the overall money supply through their lending practices, which can slow economic activity.

Demand deposits are the balances in bank accounts that can be accessed on demand without any restrictions, such as checking accounts. Calculating the total addition to demand deposits in the banking system involves the use of the demand deposit multiplier (DDM).

The formula for the DDM is \( \frac{1}{\text{required reserve ratio}} \), which indicates how much the bank can theoretically increase the money supply through its lending activities. Using this multiplier, one can calculate the potential addition to the banking system's demand deposits (TADD) by multiplying the initial deposit by the DDM. If the required reserve ratio is set to 100%, as in our example, the DDM will be 1, and thus, the total money supply remains unchanged. This information is vital for students to understand the connection between deposit intake, reserve requirements, and the overall capacity of banks to circulate new money in the economy.