Imagine that the banking system receives additional deposits of £100 million and that all the individual banks wish to retain their current liquidity ratio of 20 per cent.

(a)  How much will banks choose to lend out initially?

(b)  What will happen to banks’ liabilities when the money that is lent out is spent and the recipients of it deposit it in their bank accounts?

(c)  How much of these latest deposits will be lent out by the banks?

(d)  By how much will total deposits (liabilities) eventually have risen, assuming that none of the additional liquidity is held outside the banking sector?

(e)  How much of these are matched by (i) liquid assets; (ii) illiquid assets?

(f)  What is the size of the bank deposits multiplier?

(g)  If one-half of any additional liquidity is held outside the banking sector, by how much less will deposits have risen compared with (d) above?