The following are simplified consolidated balance sheets for the chartered banking system and the Bank of Canada.Do not cumulate your answers; that is, do return to the data given in the original balance sheets in answering each question.Assume a desired reserve ratio of 5 percent for the chartered banks.All figures are in billions of dollars.CONSOLIDATED BALANCE SHEET: CHARTERED BANKING SYSTEM BALANCE SHEET: BANK OF CANADA
Refer to the above information.Suppose the Bank of Canada buys $2 in securities from the public.As a result of this transaction, the supply of money will:
A)directly increase by $2 and the money-creating potential of the chartered banking system will increase by $38.
B)directly increase by $40 and the money-creating potential of the chartered banking system will increase by $800.
C)directly increase by $2 and the money-creating potential of the chartered banking system will be unaffected.
D)be unaffected but the money-creating potential of the chartered banking system will increase by $40.

Question

The following are simplified consolidated balance sheets for the chartered banking system and the Bank of Canada.Do not cumulate your answers; that is, do return to the data given in the original balance sheets in answering each question.Assume a desired reserve ratio of 5 percent for the chartered banks.All figures are in billions of dollars.CONSOLIDATED BALANCE SHEET: CHARTERED BANKING SYSTEM  BALANCE SHEET: BANK OF CANADA
 Refer to the above information.Suppose the Bank of Canada buys $2 in securities from the public.As a result of this transaction, the supply of money will:
A)directly increase by $2 and the money-creating potential of the chartered banking system will increase by $38. 
B)directly increase by $40 and the money-creating potential of the chartered banking system will increase by $800. 
C)directly increase by $2 and the money-creating potential of the chartered banking system will be unaffected. 
D)be unaffected but the money-creating potential of the chartered banking system will increase by $40.

Quizplus · Accepted Answer

When the Bank of Canada buys $2 in securities from the public, it credits the seller's account with $2, increasing the monetary base by $2. Since the chartered banks are required to hold reserves equal to 5% of their deposits, the initial increase in reserves of the seller will allow the chartered banks to create $38 in new deposits through the money multiplier effect ($2/0.05 = $40, minus the initial $2). Therefore, the supply of money will directly increase by $2 and the money-creating potential of the chartered banking system will increase by $38.

The Following Are Simplified Consolidated Balance Sheets for the Chartered