Suppose the banking system has $40 billion in reserves. Also assume that there are no cash leakages or excess reserves. If the central bank lowers the required reserve ratio from 20 percent to 16 percent, the money supply will

Money supply increases by $1.6 billion

Explanation:

The reserve ratio is defined as the amount of a bank's reserves that the central bank of a country expects banks to keep as cash and not lend out.

Reserve ratio is also called cash reserve ratio.

This requirement is put in place in case customers decide to make mass withdrawals.

Central banks tend to control cash supply by increasing or reducing the reserve ratio.

When money to be supplied as loans is to be increased, the reserve ratio reduces so that banks can use more of their reserves for lending rather than for cash withdrawals.

In this instance reserve ratio reduced from 20% to 16%.

That is a 4% reduction

This means 4% of the reserves is freed up for lending or money supply to the public

Extra money supply = 0.04 * 40 billion = $1.6 billion

Money supply increases by $1.6 billion

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