The Fed conducts an open market purchase of $10 million in government securities. If the reserve ratio is 20%, what is the maximum change in the money supply? Assume banks hold no excess reserves and there is no currency withdrawal from the banking system.
A) maximum increase in money supply = $10 million
B) maximum decrease in money supply = $10 million
C) maximum increase in money supply = $50 million
D) maximum decrease in money supply = $50 million

Question

Quizplus · Accepted Answer

The maximum change in the money supply can be calculated using the simple money multiplier formula: 1/RR (where RR is the reserve ratio). In this case, the reserve ratio is 20%, so the money multiplier is 1/0.2 = 5. Therefore, the maximum increase in the money supply is $10 million x 5 = $50 million.

The Fed Conducts an Open Market Purchase of $10 Million