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ECO - 252 Macroeconomics 2. Assume people hold no currency and no travelers' checks, banks loan...

ECO - 252 Macroeconomics

2. Assume people hold no currency and no travelers' checks, banks loan out all excess reserves, the required reserve ratio is 8%, and the current money supply is $200 billion.

a. What would be the new money supply if the Fed conducts an open market sale of existing bonds worth $2 billion?

b. What would be the new money supply if the Fed conducts an open market purchase of existing bonds worth $2 billion? Start with the current money supply of $200 billion.

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Answer #1

Since banks hold no excess reserves, reserve kept by banks=8%=0.08

Money multiplier=1/r=1/0.08=12.5

Money multiplier is the change in money supply due to additional unit of high powered money.

A) when fed conducts an open marlet sale of $2billion, which leads to decrease the high powered money by $2 billiion which will lead to change/decrease in money supply by 12.5*2=25 billion.

Thus new money supply=200-25=175billion

B) open market purchase of $2billion,will increase high powered by 2billion which will increase the money supply by 25billion. Thus new money supply=200+25=$225billion

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