Table 29-1
Effects of an open-market transaction on the balance sheets of banks and the fed (in millions of dollars)
-Assume the required reserve ratio is 20 percent and the FOMC orders an open-market purchase of $100 million in government securities from member banks.If the oversimplified money multiplier is assumed, then the money supply will
A)increase by $500 million.
B)increase by $100 million.
C)decrease by $100 million.
D)decrease by $500 million.

Question

Table 29-1
Effects of an open-market transaction on the balance sheets of banks and the fed (in millions of dollars)  ​
-Assume the required reserve ratio is 20 percent and the FOMC orders an open-market purchase of $100 million in government securities from member banks.If the oversimplified money multiplier is assumed, then the money supply will
A)increase by $500 million. 
B)increase by $100 million. 
C)decrease by $100 million. 
D)decrease by $500 million.

Quizplus · Accepted Answer

The money multiplier is calculated as 1/required reserve ratio. With a 20 percent reserve ratio, the multiplier is 1/0.20 = 5. Therefore, an open-market purchase of $100 million in government securities can potentially increase the money supply by $100 million * 5 = $500 million, as banks can lend out more money based on the initial increase in reserves.

Table 29-1 Effects of an Open-Market Transaction on the Balance Sheets of Sheets