Suppose the Fed sells $100 of government securities. If the desired reserve ratio is 20 percent and there is no currency drain, then the quantity of money
A)decreases by $80.
B)decreases by $400.
C)decreases by $100.
D)increases by $100.
E)decreases by $500.

Question

Quizplus · Accepted Answer

When the Fed sells $100 of government securities, it reduces the reserves in the banking system by $100. With a reserve ratio of 20%, the money multiplier is 1/0.2 = 5. Therefore, the total decrease in the money supply is $100 * 5 = $500.

Suppose the Fed Sells $100 of Government Securities