Suppose the banking system's nonborrowed reserves total $75 billion with total legal reserves standing at $98 billion. The Fed buys $5 billion of securities in the open market. What will happen to the level of borrowed reserves?
A) The level of borrowed reserves will fall to $18 billion
B) The level of borrowed reserves will rise to $80 billion
C) The level of borrowed reserves will fall to $93 billion
D) The level of borrowed reserves will rise to $23 billion
E) Borrowed reserves will be unaffected

Question

Quizplus · Accepted Answer

When the Fed buys $5 billion of securities in the open market, it increases the banking system's reserves by $5 billion. If nonborrowed reserves were $75 billion and total reserves were $98 billion, then borrowed reserves were $23 billion ($98 billion - $75 billion). After the Fed's purchase, nonborrowed reserves increase to $80 billion ($75 billion + $5 billion), so total reserves increase to $103 billion. Since the question asks about the level of borrowed reserves after the purchase and implies that the total legal reserves change due to the Fed's action, the borrowed reserves remain at $23 billion, not directly affected by the transaction. However, the premise of the question and the options provided seem to suggest an expectation of a direct calculation or impact on borrowed reserves, which might not align with the explanation given. The correct interpretation based on the provided options and the typical understanding of such transactions would be that borrowed reserves are indirectly affected because the increase in nonborrowed reserves reduces the need for borrowed reserves. However, none of the options accurately reflects this scenario based on the standard calculation, suggesting a potential misunderstanding in the framing of the question and answer options.

Suppose the Banking System's Nonborrowed Reserves Total $75 Billion with Total