Assume that individuals hold cash and banks hold some excess reserves. If the reserve requirement is 10 percent and the Federal Reserve buys $100 of Treasury securities from a bank, then money supply will:

Question

Quizplus · Accepted Answer

When the Federal Reserve buys $100 of Treasury securities, it increases the reserves of the bank by $100. With a reserve requirement of 10%, the money multiplier is 1/0.10 = 10. Therefore, the potential increase in the money supply is $100 x 10 = $1,000. However, since individuals hold cash and banks hold excess reserves, the actual increase will be less than $1,000.

Assume That Individuals Hold Cash and Banks Hold Some Excess