Question

The FOMC has instructed the FBRNY Trading Desk to purchase $480 million in US Treasury securities. The Federal Reserve has currently set the reserve requirement at 6 percent of transaction deposits. Assume US banks withdraw all excess reserves and give out loans.

A. Assume that borrowers eventually return all of these funds to their banks in the form of transaction deposits. What is the full effect of this purchase on bank deposits and the money supply?

___ in bank deposits and money supply _____ billion.

B. What is the full effect of this purchase on bank deposits and the money supply if borrowers return only 94 percent of these funds to their banks in the form of transaction deposits?

____ in bank deposits and money supply ____ billion.

Answer 1

Answer : (a.) By Assumig that borrowers eventually return all of these funds to their banks in the form of transaction deposits there will be INCREASE  in bank deposits and money supply by 6.6 billion i.e [(1 / 0.06) * 480million = 8000 million or 8 billion]

(b.) The full effect of this purchase on bank deposits and the money supply if borrowersreturn only 94 percent of these funds to their banks in the form of transaction deposit is INCREASE  in bank deposits and money supply by 3.3 billion i.e [(1 / {(0.06) + (1 - 0.94)} * 480million = 4000 million or 4 billion]