If the reserve ratio is 10%, and banks do not hold excess reserves, when the Fed purchases $10 million of government bonds, bank reserves
A) increase by $10 million and the money supply could eventually increase by $10 million.
B) decrease by $10 million and the money supply could eventually decrease by $100 million.
C) increase by $10 million and the money supply could eventually increase by $100 million.
D) decrease by $10 million and the money supply could eventually decrease by $10 million

Question

Quizplus · Accepted Answer

When the Fed purchases $10 million of government bonds, bank reserves increase by $10 million. With a reserve ratio of 10%, the money multiplier is 1/0.10 = 10. Therefore, the money supply could eventually increase by $10 million * 10 = $100 million.

If the Reserve Ratio Is 10%, and Banks Do Not