Assume that the reserve requirement is 20% and the Federal Open Market Committee buys a $100,000 bond. The money supply
A) increases by a maximum of $100,000.
B) decreases by $100,000.
C) increases by a maximum of $20,000.
D) increases by a maximum of $500,000.

Question

Quizplus · Accepted Answer

When the Federal Open Market Committee buys a $100,000 bond, it injects $100,000 into the banking system. With a reserve requirement of 20%, banks are required to keep 20% of deposits as reserves and can lend out the remaining 80%. This process of lending and re-depositing can theoretically increase the money supply by up to 5 times the original amount ($100,000), due to the money multiplier effect (1 / Reserve Requirement), which in this case is 1 / 0.20 = 5. Therefore, the money supply can increase by a maximum of $500,000.

Assume That the Reserve Requirement Is 20% and the Federal