Assume that the reserve requirement ratio is 12 percent and that the Fed uses open market operations to buy $200 million worth of Treasury securities. Assuming that banks use all funds exceptrequired reserves to make loans and that the public does not store any cash, the money supply should ____ by about ____.
A) increase; $200 million
B) increase; $1.67 billion
C) decrease; $200 million
D) decrease; $1.67 billion

Question

Quizplus · Accepted Answer

The initial impact of the Fed's open market purchase of $200 million worth of Treasury securities is to increase banks' reserve balances by the same amount. Since the reserve requirement ratio is 12 percent, banks are required to hold only $24 million (12% of $200 million) of total reserves. Banks can lend out the remaining amount, which is $176 million ($200 million - $24 million). Assuming that all funds except required reserves are used to make loans, the money supply should increase by a multiple of the initial injection, which is 1/0.12 times the $176 million increase in reserves. Therefore, the money supply should increase by about $1.67 billion ($176 million x 1/0.12).

Assume That the Reserve Requirement Ratio Is 12 Percent and That