Question

Category	Value
Total Reserves (private banks)	$100 Billion
Currency (firms, households)	$50 Billion
Value of Euros in the U.S. (private banks, firms, households)	$1 Billion
Gov’t bonds (private banks, firms, households)	$30 Billion
Demand deposits (private banks)	$1 Trillion
Certificates of Deposit, CDs (private banks)	$10 Billion
Reserve requirement on demand deposits	.10

Suppose the Fed buys $40 billion bonds from private banks. What is the total amount of reserves banks can lend and how much additional money is created by this?

Answer 1

It has been stated that Fed buys $40 billion bonds from private banks.

This purchase of $40 billion bonds by Fed from private banks will create excess reserves of $40 billion with private banks.

Private banks can only lend excess reserves they held.

So,

The total amount of reserves that bank can lend is $40 billion.

Reserve requirement = 0.10

Calculate the money multiplier -

Money multiplier = 1/reserve requirement = 1/0.10 = 10

Calculate the additional money created -

Additional money created = Excess reserves created * Money multiplier

Additional money created = $40 billion * 10 = $400 billion

The additional money created would be $400 billion.