If the Bank of Canada enters the open market and purchases $1000 of government securities, what will be the eventual change in the money supply given a 10 percent target reserve ratio in the commercial banking system?

Question

Quizplus · Accepted Answer

When the Bank of Canada purchases $1000 of government securities, it pays for them by depositing $1000 in the selling bank's account. This increases the bank's reserves by $1000. Given a 10 percent reserve ratio, the bank can now lend out up to $900 of this newly acquired reserve. As this $900 is loaned out, it becomes a new deposit in another bank, which will in turn lend out 90 percent of the deposit. This process continues until the increase in the money supply is equal to the initial increase in reserves. Therefore, the eventual change in the money supply will be an increase of $10 000.

If the Bank of Canada Enters the Open Market and Purchases