Why is the multiplier 1 divided by the reserve ratio?

Because each dollar of reserves supports 1 / r dollars of deposits, assuming no excess reserves and no extra cash holding by the public.

Do I have to memorise the money definitions?

Yes. The M1 and M2 boundary is easy marks; just remember that M2 adds savings and time deposits.

S6 Economics | Monetary Policy Practice Paper 1 (Foundation)

2026-11-04

Tutor Prep Guide · Secondary Economics

Start from the deposit multiplier and reserve ratio, then move to open market operations, money supply definitions, the Fisher equation and the quantity theory, covering the six most examined calculations in one set.

Attempt first, mark afterwards　Allow about thirty minutes; write the multiplier or the equation for each item before checking it, then use the explanation to find the step you missed.

01　Paper details (check answers afterwards)

Item	Detail
Questions	10 items
Suggested time	About 30 minutes
Difficulty mix	Foundation 4 · Intermediate 3 · Challenge 2 · Error redo 1
Chapter	Chapter: S6 Economics \| Monetary Policy
Level	S6 (Secondary 6) Economics

02　Questions (10 items)

FoundationThe banking system holds 500 billion in reserves and the required reserve ratio is 10%, with no excess reserves. What is the simple deposit multiplier?
FoundationContinuing from the previous item, how many billion of deposits can these 500 billion of reserves support at most?
FoundationUnder the Hong Kong money supply definitions, what are the two main components of M1?
FoundationThe central bank buys government bonds in the open market. What happens to banking system reserves and the money supply?
IntermediateThe required reserve ratio falls from 10% to 8% with everything else unchanged. From what to what does the deposit multiplier rise, and by what percentage?
IntermediateThe central bank sells 50 billion of bonds, the required reserve ratio is 10% and banks hold no excess reserves. By how much can the money supply fall at most?
IntermediateThe nominal interest rate is 6% and expected inflation is 2.5%. Using the exact Fisher equation, what is the real interest rate?
ChallengeThe public holds 200 billion in cash and banks hold 1,000 billion of deposits (cash-to-deposit ratio 0.2), the required reserve ratio is 10% and there are no excess reserves. Find the money multiplier and the money supply.
ChallengeQuantity theory MV = PY: money supply is 400 billion, velocity 5 and real output 500 billion. Find the price level; if the money supply rises 10% while V and Y are unchanged, what is the new price level?
Error redoError review: a student claims that a rate cut always makes households borrow more, so the money supply must rise. Is that correct?

03　Answers and one-line notes

#	Answer	One-line note
1	10	The deposit multiplier is 1 divided by the required reserve ratio, that is 1 / 0.10 = 10, so each extra dollar of reserves supports up to 10 dollars of deposits.
2	5,000.0 billion	500 x 10 = 5,000.0; the multiplier scales reserves up into deposits, not the other way round.
3	Notes and coins held by the public plus demand deposits with banks	M1 counts only cash in the hands of the public and demand deposits available on demand; cash held by banks and time deposits are excluded, and time deposits belong to M2.
4	Reserves rise and the money supply expands	Buying bonds pays cash to the banks, so their reserves increase and their lending base grows, which expands the money supply; selling bonds does the reverse.
5	From 10 to 12.5, a rise of 25.0%	1 / 0.10 = 10 and 1 / 0.08 = 12.5, so the rise is (12.5 – 10) / 10 = 25.0%.
6	By up to 500.0 billion	50 x 10 = 500.0; selling bonds drains reserves, and multiplying by the deposit multiplier gives the maximum contraction.
7	About 3.4%	(1 + 0.06) / (1 + 0.025) – 1 = 3.4%; the rough nominal-minus-inflation rule gives 3.5%, which differs by 0.1 percentage point.
8	Multiplier 4, money supply 1,199.9999999999998 billion	Multiplier = (1 + 0.2) / (0.2 + 0.10) = 4; base money = 200 + 100 = 300, and 300 x 4 = 1,199.9999999999998 billion.
9	P = 4.0; after the 10% rise, P = 4.4	400 x 5 / 500 = 4.0; with M up 10% and V and Y unchanged, P rises by the same 10%, giving 4.4.
10	No; a rate cut only lowers the cost of borrowing, and whether lending and the money supply rise depends on confidence, banks willingness to lend and credit demand	When the outlook is poor, banks tighten credit and firms postpone investment, so a rate cut may not lift borrowing at all; policy lags can also break the transmission.

04　What to do after marking

After marking, redo only the wrong items and write down which step went wrong (formula, unit, or misread number).
Repeat the same item two days later; move to the next paper only when both attempts are correct.
Parents only need the answer and note columns; there is no need to explain every item.

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