Suppose a securities dealer sells a $10,000 Treasury bond to the Fed and deposits the money in its bank account. If the required reserve ratio is 10 percent, and if banks loan out all of their excess reserves, then what is the maximum increases in the money supply after the multiplier effect has fully operated?

Question

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The initial deposit of $10,000 creates excess reserves of $9,000 ($10,000 minus the required reserve ratio of 10 percent). Assuming banks loan out all of their excess reserves, this creates a new deposit of $9,000 in another bank. This second bank can then loan out 90 percent of the $9,000, or $8,100, which creates a new deposit of $8,100 in another bank. This process continues, with each bank loaning out 90 percent of the new deposit created, until the maximum increase in the money supply is reached.

Using the formula for the money multiplier, we can calculate the maximum increase in the money supply as:

1 / Reserve Ratio = 1 / 0.10 = 10

10 x Initial Deposit = 10 x $10,000 = $100,000

Therefore, the maximum increase in the money supply after the multiplier effect has fully operated is $100,000.

Suppose a Securities Dealer Sells a $10,000 Treasury Bond to the Fed