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Exhibit: Fed Buys Bonds
Scenario 1: Fed Buys Bonds from Sheila Jones
Consider a banking system in which the reserve requirement is 10%, banks try not to hold excess reserves, consumers and firms hold money only in the form of checking account balances, and all loan proceeds are spent. Suppose initially all banks in the system are loaned up. Now, suppose that the Fed buys a $100,000 bond from Sheila Jones, who banks at the Perez Bank, and that she deposits her check in her checking account at Perez Bank.
-(Exhibit: Fed Buys Bonds) Which of the following happens when Sheila Jones deposits the proceeds from the sale of her bond to the Fed into her checking account at the Perez Bank?
A) Perez Bank's checkable deposits increases by $100,000 and its reserves increases by $90,000.
B) Perez Bank's checkable deposits and reserves increase by $100,000 each.
C) Perez Bank's checkable deposits increases by $90,000 and its reserves increases by $100,000.
D) Perez Bank's checkable deposits and reserves increase by $90,000 each.

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When Sheila Jones deposits the proceeds from the sale of her bond to the Fed into her checking account at the Perez Bank, Perez Bank's checkable deposits and reserves both increase by $100,000 each. This is because the Fed's purchase of the bond from Sheila Jones results in an increase in the reserves of Perez Bank by $90,000 (10% of the bond value) and an increase in its deposits by $100,000, as the deposit is made in the form of a checkable deposit. The bank can choose to hold on to the extra $10,000 in reserves or lend it out, but in either case, both deposits and reserves increase by $100,000 each.

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