Assume that the required reserve ratio is 20 percent.If the Federal Reserve buys $80 million in government securities from commercial banks, then the money supply will immediately
A)increase by $0 with this transaction, and the maximum money-lending potential of the commercial banking system will increase by $400 million.
B)increase by $0 with this transaction, but the maximum money-lending potential of the commercial banking system will increase by $320 million.
C)increase by $80 million with this transaction, and the maximum money-lending potential of the commercial banking system will increase by another
D)increase by $80 million with this transaction, and the maximum money-lending potential of the commercial banking system will decrease by another

Question

Quizplus · Accepted Answer

The purchase of government securities by the Federal Reserve increases the reserves of commercial banks, which allows them to lend more money. The required reserve ratio is 20%, so for every $1 of reserves, banks can lend out $5. Therefore, the $80 million purchase of government securities will increase the maximum money-lending potential of the commercial banking system by $400 million.

Assume That the Required Reserve Ratio Is 20 Percent