Question

1. 1. The banking system currently has $100 billion of reserves, none of which are excess. People hold only deposits and no currency, and the reserve requirement is 10 percent. If the Fed lowers the reserve requirement to 5 percent and at the same time buys $10 billion worth of bonds, then by how much does the money supply change?
      1. It rises by $200 billion.
2. 2. It rises by $800 billion.
3. 3. It rises by $1,200 billion.
4. 4. None of the above is correct.

Answer 1

Ans.Correct Option is rises by $1200 billion

At 10% reserves were at 100 billion

So , at 5% means that reserve will get hallfed and will be at 50 billion.

Reserve Ratio = 5% or 0.05

Multiplier = 1 / 0 .05 = 20

Money supply = 50 x 20 = $1000 billion

Additional bond bought at 10 billion -

Money supply = 10 x 20 = $200 billion

Increase in Money Supply = 1000 + 200 = $1200 billion.

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