If the State Bank buys a government bond worth Rs 1,000 from you, and you deposit the entire amount into your bank, what is the maximum possible increase in the money supply given that your bank maintains a reserve ratio of 20%?

Explanation

When the State Bank purchases a Rs 1,000 government bond, it injects Rs 1,000 into the banking system. With a reserve ratio of 20%, the money multiplier is 1 divided by 0.20, which equals 5. Therefore, the total potential increase in the money supply is Rs 1,000 multiplied by 5, resulting in Rs 5,000.