Question

# The FOMC has instructed the FRBNY Trading Desk to purchase \$360 million in U.S. Treasury securities....

The FOMC has instructed the FRBNY Trading Desk to purchase \$360 million in U.S. Treasury securities. The Federal Reserve has currently set the reserve requirement at 6 percent of transaction deposits. Assume U.S. banks withdraw all excess reserves and give out loans.

a. Assume also 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?

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?

(a)

\$6 billion

Explanation:

Given that,

Treasury securities purchased = \$360 million

Reserve requirement = 6% of the deposits

Therefore,

Increase in bank deposits and money supply:

= (1 / 0.06) x 360

= 16.67 × \$360 million

= \$6,000 million

= \$6 billion

Hence, there is an increase in the bank deposits and money by \$6 billion.

(b)

5.64 billion

if banks are returned with only 94% of the money supply then -

increase in money supply = 6 billion x 94%

= 6 x 0.94

= 5,640 million or 5.64 billion