Question

Suppose the Fed buys U.S. Treasury securities from Bank of America. According to the simple model of multiple deposit​ creation, this purchase will cause the money supply to

1.remain constant/increase/decrease?

with the magnitude of the increase conditioned​ (in part) upon the size of the banking​ system's

2.reserve/ lending/capital? requirement.

The simple model of multiple deposit creation hinges on the two basic assumptions that

A.

none of the money created is added to household or business cash holdings and banks hold no excess reserves.

B.

all money created through bank lending is deposited in banks and banks hold a safe level of excess reserves.

C.

all money created through bank lending is deposited in banks and banks lend all of their excess reserves.

D.

all of the above.

E.

A and C only.

Answer 1

Answer 1: Increase.

Purchase of government securities by the Fed will lead to increase in the amount of money supplied in the economy.

Answer 2: Reserve.

The magnitude of the increase depends on the size of the bank's reserve requirement. As reserve requirement decreases, the increase in money supply increases and as reserve requirement increases, the increase in money supply decreases.

Answer 3:Option E.

The model of simple deposit creation is based on the assumption that none of the money created is added to household or business cash holdings and banks hold no excess reserves and all money created through bank lending is deposited in banks and banks lend all of their excess reserves. Thus, both A and C are correct.