Question

Suppose the required reserve ratio is 10%, excess reserves holdings are 65% of deposits, and currency holdings are 45% of deposits. If the Fed buys $500 million worth of securities, what will be the change in the money supply (measured in dollars)?

Answer 1

The money multiplier can be calculated by the following formula:

Here, r is the required reserve to deposit ratio, c is the currency to deposit ratio and e is the excess reserve to deposit ratio.

It is given that the central bank buys $500 million worth of securities. The money supply will increase by multiplier times $500. So,

So, the money supply will increase by $604.167 (approximately).