Assuming that households do not change their cash holdings and banks loan out all of their excess reserves,if the required reserve ratio (RRR)is 10 percent and the Fed purchases $2,000 worth of bonds from banks,how much money will be eventually created?

Question

Quizplus · Accepted Answer

If the required reserve ratio (RRR) is 10 percent, then for every $100 of deposits, banks have to hold onto $10 in reserves and can lend out $90. If the Fed purchases $2,000 worth of bonds from banks, the banks' reserves increase by $2,000. Since the banks now have an excess of $2,000 in reserves, they can increase their lending by $2,000 x (1/RRR) = $2,000 x (1/0.1) = $20,000. Therefore, the eventual increase in the money supply is $20,000 - $2,000 = $18,000. Thus, the best choice is E) $20,000.

Assuming That Households Do Not Change Their Cash Holdings and Banks