Suppose that the Fed purchases a $1,000 government bond from you.If you deposit the entire $1,000 in your bank, what is the total potential change in the money supply as a result of the Fed's action if reserve requirements are 10 percent?

Question

Quizplus · Accepted Answer

When the Fed purchases a $1,000 government bond and you deposit the entire amount in your bank, the bank can lend out 90% of that deposit (since the reserve requirement is 10%). The $900 lent out can be deposited in another bank, which can lend out 90% of that, and so on. This process continues, creating a multiplier effect on the money supply. The total potential change in the money supply is calculated using the money multiplier formula, which is 1/reserve requirement. In this case, it's 1/0.10 = 10. Therefore, the total potential change in the money supply is $1,000 * 10 = $10,000.

Suppose That the Fed Purchases a $1,000 Government Bond from You.If