Suppose banks desire to keep 5 percent of all deposits on reserve, and the Fed purchases $10 million of government securities from a private securities dealer. Then,

Question

Quizplus · Accepted Answer

When the Fed purchases $10 million of government securities, this injects $10 million into the banking system. With a reserve requirement of 5%, banks can lend out 95% of any new deposits. This creates a multiplier effect, where the initial $10 million can increase total deposits in the economy by up to $200 million ($10 million / 0.05 = $200 million), as banks lend out 95%, those funds are deposited, and the process repeats.

Suppose Banks Desire to Keep 5 Percent of All Deposits