Question

# Suppose the Fed bought \$150 million of U.S. securities from security dealers. The reserve requirement is...

Suppose the Fed bought \$150 million of U.S. securities from security dealers. The reserve requirement is 20 percent, and there are no initial excess reserves. A few weeks later, if the public's holdings of currency are constant and the banks have loaned all excess reserves. the money supply will increase by:
A) \$150 million
B) \$750 million
C) \$600 million
D) \$300 million

The Fed has bought \$150 million of US securities.

This will increase the reserves with banks by \$150 million.

When Fed purchase securities then excess reserves are created.

So, excess reserves worth \$150 million are created by this action of bank.

All the excess reserves can be used for lending.

Reserve requirement = 20% or 0.20

Money multiplier = 1/Reserve requirement = 1/0.20 = 5

The money multiplier is 5.

Calculate the increase in money supply -

Increase in money supply = Excess reserves created * Money multiplier

Increase in money supply = \$150 million * 5 = \$750 million

Thus,

The money supply will increase by \$750 million.

Hence, the correct answer is the option (B).