Scenario 2: Fed sells bonds to Henry Hyde
Consider a banking system in which the reserve requirement is 10%, banks try not to hold excess reserves, consumers and firms hold money only in the form of checking account balances, and all loan proceeds are spent. Suppose initially all banks in the system are loaned up. Now, suppose that the Fed sells a $50,000 bond to Henry Hyde, who pays for the bond by writing a check drawn against Jekyll Bank.
-Refer to Scenario 2. As a result of the open market sale, Jekyll Bank
A) can create $50,000 of new loans.
B) will have $45,000 of excess reserves.
C) will have to borrow reserves to replenish its reserve deficiency.
D) will have an increase in checkable deposits.

Question

Quizplus · Accepted Answer

When the Fed sells a bond to Henry Hyde, the reserves of Jekyll Bank decrease by $5,000 (10% of $50,000), creating a reserve deficiency. Jekyll Bank will need to replenish its reserves either by calling in loans or borrowing reserves from other banks or the Fed. Therefore, Jekyll Bank will have to borrow reserves to replenish its reserve deficiency. None of the other options are correct, as the sale of the bond does not directly create new loans or excess reserves, nor does it necessarily result in an increase in checkable deposits for Jekyll Bank.

Scenario 2: Fed Sells Bonds to Henry Hyde