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

Question

Quizplus · Accepted Answer

When the Bank of Canada sells $1000 of government securities in the open market, the buyers will pay for it with their reserves, thus the reserves of the commercial banks will decrease by $1000. If the target reserve ratio is 10%, this means that banks can loan out 90% of the decrease in reserves, which is $900. However, there is also a 10% cash drain, which means that $90 of the newly created deposits will be held as cash, and the remaining $810 will be deposited back into the banking system. Thus, the eventual change in the money supply will be a decrease of $5000.

If the Bank of Canada Enters the Open Market and Sells