Assume a money multiplier of 2. If the Treasury finances a $10 million expenditure by selling securities to the Fed, bank reserves will
A) remain unchanged.
B) rise by $5 million.
C) rise by $10 million.
D) rise by $20 million.

Question

Quizplus · Accepted Answer

The money multiplier is calculated as 1/required reserve ratio, meaning that for a multiplier of 2, the required reserve ratio is 0.5. Therefore, for the $10 million expenditure to result in a $20 million increase in the money supply, banks must lend out $10 million of the new reserves created by the Fed's purchase of securities. Hence, bank reserves will rise by the same amount as the expenditure, which is $10 million.

Assume a Money Multiplier of 2