Suppose the Fed buys $100,000 of U.S. Treasury bonds from Bill Gates. If the reserve requirement is 10 percent, the currency holdings of the public are unchanged, and banks have zero excess reserves both before and after the transaction, the total impact on the money supply will be
A) an increase by $100,000.
B) an increase by $1,000,000.
C) a decrease by $100,000.
D) a decrease by $1,000,000.

Question

Quizplus · Accepted Answer

When the Fed buys $100,000 of U.S. Treasury bonds from Bill Gates, it pays him with a check drawn on the Fed. This check is deposited in his bank account, which creates a $100,000 increase in the bank's reserves. Since the reserve requirement is 10 percent, the bank can lend out $90,000 of those reserves, which will be deposited in another bank, creating another $81,000 of deposits. This process continues, with each bank being able to lend out 90 percent of the new deposits it receives, until the total increase in the money supply is $1,000,000.

Suppose the Fed Buys $100,000 of U