If the reserve ratio is 20 percent, then $100 of new reserves can generate $500 of new money in the economy.
We must identify the economy's money multiplier in order to determine how much a new reserve can contribute to that economy. We can determine the money multiplier if we are aware of the reserve ratio of the banking system.
The formula for money multiplier is 1/Reserve ratio
In the question the reserve ratio is 20% or 0.2 we will put this in the formula in order to find the money multiplier
Money multiplier = 1/0.2= 5
Now in order to find how much can a new reserve generate we will multiply the new reserve by the multiplier.
New reserve = $100
Money multiplier = 5
5*100= 500
So a $100 new reserve can generate $500 of new money in the economy.
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