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If the Fed buys $1,000 of government bonds from you and you hold all of the...

If the Fed buys $1,000 of government bonds from you and you hold all of the payment as currency at home, by how much does the money supply rise?

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Answer #1

Money supply is increased when banks convert their excess reserves into loans and those loans are than entered once again in the banking system as deposits and hence the money is generated. If there is an increase in the currency of $1,000 when the Fed purchase is $1,000 worth of Bond from public, there no increase in either the deposit or in the excess reserves so that no loans are generated. Therefore the monetary base is increased by $1,000 and money supply is also increased by this amount. This happens because money multiplier is one when currency deposit ratio is zero and there are no excess reserves.

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