Question

Assume that the banking system is fully loaned up and that any open-market purchase by the Fed directly increases reserves in the banks. If the required reserve ratio is 0.15.  By how much could the money supply expand if the Fed purchased $1.75 million worth of bonds?

Assume that the banking system is fully loaned up and that any open-market purchase by the Fed directly increases reserves in the banks. If the required reserve ratio is 0.15.  What is the initial increase in reserves needed to cover loans made on the $1.75 million worth of bonds?

Answer 1

Question 1

It has been provided that any open-market purchase by the Fed directly increases reserves in the banks.

The Fed has purchased the $1.75 million worth of bonds.

So, this purchase of $1.75 million worth of bonds will increase the reserves with banks by $1.75 million.

Required reserve ratio = 0.15

Money multiplier = 1/Required reserve ratio

Money multiplier = 1/0.15 = 6.67

The money multiplier is 6.67

Calculate the total increase in money supply -

Total increase in money supply = Increase in bank reserves * money multiplier

Total increase in money supply = $1.75 million * 6.67 = $11.67 million

Thus,

The money supply will expand by $11.67 million.