Assume that all money in the economy is deposited with banks and that banks hold no excess reserves. If the reserve requirement is 10 percent and the Federal Reserve buys $10 million worth of Treasury securities, then the money supply will increase by:

Question

Quizplus · Accepted Answer

The money supply will increase by $100 million because when the Federal Reserve buys $10 million worth of Treasury securities, this initial injection serves as a base for money creation through the banking system. With a 10 percent reserve requirement, banks can lend out 90% of their deposits. This process of lending and redepositing can theoretically increase the money supply up to a total of $100 million, calculated as the initial injection ($10 million) multiplied by the money multiplier (1 / reserve requirement ratio, or 1 / 0.10 = 10).

Assume That All Money in the Economy Is Deposited with Banks