The Fed conducts an open-market sale of Treasury bills of $5 million.If the required reserve ratio is 0.20, what change in the money supply can be expected using the oversimplified money multiplier?
A)$25 million
B)$5 million
C)0
D)−$5 million
E)−$25 million

Question

Quizplus · Accepted Answer

With the oversimplified money multiplier method, we can calculate the potential change in the money supply as:
Change in money supply = (1/required reserve ratio) x change in reserves
In this case, the change in reserves is -$5 million (due to the open-market sale) and the required reserve ratio is 0.20. Therefore, the potential change in the money supply is:
Change in money supply = (1/0.20) x (-$5 million) = -$25 million
Note that this method assumes that all bank reserves are held as required reserves and there are no leakages (such as excess reserves or currency drains) in the banking system, which is why it is an oversimplified approach.

The Fed Conducts an Open-Market Sale of Treasury Bills of $5