Suppose the required reserve ratio is 10 percent. Find the required reserves, excess reserves, and the maximum amount by which demand deposits could expand. The required reserve ratio gives the percent of deposits that banks must hold as reserves. It is the ratio of required reserves to deposits. If the required reserve ratio is 10 percent this means that banks must hold 10 percent of their deposits as required reserves.
Excess reserves are reserves over and above required reserves.
However, as this money circulates through the system, there would be further increases in the money supply. ADD is the expansion of demand deposits, AER is the excess reserves in the banking system, and r is the required reserve ratio. Suppose the required reserve ratio is 25 percent. Assume that banks lend aH of their excess reserves and the public does not add to its cash holdings. Because demand deposits are one component of the money supply, the increase in demand deposits results in an increase in the money supply.