Question

Let's say that the Federal Reserve purchases $1 Million worth of U.S. Treasury bonds from a bond dealer in the open market, and the dealer's bank credits the dealer's account. The required reserve ratio is 15 percent, and the bank typically lends any excess reserves immediately.

a) Assuming that no currency leakage occurs, how much will the bank be able to lend to its customers following the Fed's purchase? Please explain and show your calculations.

b) Using the simple money multiplier, how much money will be created (assuming every dollar is lent out)? Please explain and show your calculations.

Can an expert please help me solve this? As it is for my macro economics class.   

Answer 1

a) Required reserve ratio is 15%. Hence the bank will keep 15% of 1 million or 0.15 million as required reserves and will lend the remaining 0.85 million as loans.

b) Simple deposit money multiplier is 1/RR = 1/15% = 6.67. Assuming that this 0.85 million as loans gets deposited in some other bank account and that bank also keeps 15% of 0.85 million as reserves, and that this goes on and on with no currency leakage, the total increase in money supply = 6.67*1 million = 6.67 million in total.