If the Fed purchases $100,000 of government bonds, and the reserve requirement is 20 percent, the maximum increase in the money supply is $ 500,000.

Question

Quizplus · Accepted Answer

If the Fed purchases $100,000 of government bonds, this increases the reserves of the banks by $100,000. However, since the reserve requirement is 20%, banks only need to hold $20,000 in reserves and can lend out the remaining $80,000. This lending creates new deposits, which can potentially circulate through the economy and increase the money supply. Using the money multiplier formula, the maximum increase in the money supply can be calculated as follows:

Maximum Increase in Money Supply = (1/Required Reserve Ratio) x Initial Increase in Reserves
= (1/0.20) x $100,000
= $500,000

Therefore, the statement is true.

If the Fed Purchases $100,000 of Government Bonds, and the Reserve