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 given a 10% target reserve ratio in the commercial banking system and a 10% cash drain?

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. Given a 10% reserve ratio, this initial removal could support a $10,000 increase in the money supply under the money multiplier effect if it were an addition instead of a removal. However, considering the 10% cash drain, the effective multiplier is reduced. The formula for the adjusted multiplier in this context is 1 / (Reserve Ratio + Cash Drain Ratio), which equals 1 / (0.10 + 0.10) = 5. Therefore, the $1000 removed from the system results in a $5000 decrease in the money supply, as each dollar could have supported five times its amount in the money supply due to the multiplier effect.

If the Bank of Canada Enters the Open Market and Sells