The banking system currently has $50 billion of reserves,none of which are excess.People hold only deposits and no currency,and the reserve requirement is 10 percent.If the Fed raises the reserve requirement to 12.5 percent and at the same time sells $10 billion worth of bonds,then by how much does the money supply change?
A)It falls by $20 billion.
B)It falls by $110 billion.
C)It falls by $180 billion.
D)None of the above is correct.

Question

Quizplus · Accepted Answer

The initial money supply is $500 billion (since reserves are $50 billion and the reserve requirement is 10%). When the reserve requirement increases to 12.5%, the money multiplier decreases from 10 to 8. The Fed selling $10 billion in bonds reduces reserves to $40 billion. With the new reserve requirement, the money supply becomes $320 billion (40 billion * 8). Thus, the money supply falls by $180 billion ($500 billion - $320 billion).

The Banking System Currently Has $50 Billion of Reserves,none of Which