The banking system currently has $100 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 lowers the reserve requirement to 5 percent and at the same time buys $10 billion worth of bonds,then by how much does the money supply change?
A)It rises by $200 billion.
B)It rises by $800 billion.
C)It rises by $1,200 billion.
D)None of the above is correct.

Question

Quizplus · Accepted Answer

The initial money supply is $1,000 billion (10 times the reserves due to the 10% reserve requirement). Lowering the reserve requirement to 5% allows the money supply to expand to $2,000 billion. The Fed's purchase of $10 billion in bonds adds another $200 billion to the money supply (20 times the bond purchase due to the new 5% reserve requirement). The total increase is $1,200 billion.

The Banking System Currently Has $100 Billion of Reserves,none of Which