Question

The FOMC has instructed the FRBNY Trading Desk to purchase $770 million in U.S. Treasury securities. The Federal Reserve has currently set the reserve requirement at 10 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 90 percent of these funds to their banks in the form of transaction deposits?

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 7.7 billion i.e [(1 / 0.10) * 770million = 7700 million or 7.7 billion]

(b.) The full effect of this purchase on bank deposits and the money supply if borrowersreturn only 90 percent of these funds to their banks in the form of transaction deposit is INCREASE  in bank deposits and money supply by 3.85 billion i.e [(1 / {(0.10) + (1 - 0.90)} * 770million = 3850 million or 3.85 billion]