Assume the Fed's required reserve ratio is 12%. Further assume that the Fed buys $10 million of U.S. Treasury securities from a dealer who deposits the check, which is drawn on the Fed, in his bank. His bank's reserve account with the Fed has increased by $10 million and so have its (demand) deposits, its total reserves, and the overall level of M₁. However, required reserves have risen only by $1.2 million. This leaves an additional $8.8 million that the bank is free and eager to invest in order to improve its income.

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When the Fed buys securities from a dealer and pays with a check drawn on the Fed, the dealer's bank adds that amount to its reserves. Since the required reserve ratio is 12%, only $1.2 million of the $10 million increase in reserves is required to be held as reserves. The remaining $8.8 million can be used for lending and investment, which can earn additional income for the bank.

Assume the Fed's Required Reserve Ratio Is 12