Question

suppose that the reserve requirement is $20 percent. Also assume that banks do not hold excess reserves and there is no cash held by the public. The Fed decides that it wants to expand the money supply by $80 million.

a- if the Fed is using open-market operations, will it buy or sell bonds?

b- what quantity of bonds does the Fed need to buy or sell to accomplish the goal? Explain your reasoning.

Answer 1

When central bank wants to increase liquidity in the economy it will buy bonds and pay money to the sellers, in this way it will inject money in the economy.

Opposite will happen when Fed wants to decrease money supply.

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Reserve requirement = 20%

Multiplier = 1/.2 = 5

Money supply needed to increase = 80 million

Amount of bond need to be bought = 80/5 = $16 million