If the Bank of Canada enters the open market and sells $1000 of government securities,what will be the eventual change in the money supply if commercial banks lend out all excess reserves and they have a 2.5% target reserve ratio?

Question

Quizplus · Accepted Answer

When the Bank of Canada sells $1000 of government securities in the open market, it effectively removes $1000 from the banking system. With a 2.5% reserve ratio, banks can lend out 97.5% of their deposits. The money multiplier is 1 / reserve ratio = 1 / 0.025 = 40. Therefore, the initial $1000 reduction in reserves leads to a $40,000 decrease in the money supply, as banks lend less due to having fewer reserves.

If the Bank of Canada Enters the Open Market and Sells