Assume that the M1 multiplier is 2.5. If the Federal Reserve purchases $200 worth of government securities, the money supply will
A) rise by $200.
B) rise by $500.
C) fall by $200.
D) fall by $500.

Question

Quizplus · Accepted Answer

The M1 multiplier indicates the amount by which the money supply will increase for every dollar increase in reserves. In this case, the purchase of $200 in government securities will increase the reserves of the banking system by $200. Since the M1 multiplier is 2.5, the money supply will increase by 2.5 times the increase in reserves, which is $500 ($200 x 2.5). Therefore, the correct choice is B.

Assume That the M1 Multiplier Is 2