Question

Suppose the Federal Reserve decided to purchase $10 billion worth of government securities in the open market. How will the lending capacity of the banking system be affected if the reserve requirement is 10 percent?

Answer 1

Reserve Requirement= 10%

Money Multiplier= 1/Reserve Requirement= 1/10%= 10

If the Federal Reserve decided to purchase $10 billion worth of government securities then there would be an increase in the lending capacity and in the Money Supply of the banking system as the deposits in the banking system would increase.

Increase in lending capacity= Money Multiplier× Total Purchases of government Securities by Federal Reserve= 10× $10 billion= $100 billion

Lending capacity of the banking system would increase by $100 billion.