In a fractional reserve banking system with no excess reserves and no currency holdings, suppose the central bank buys $100 million of bonds. Which of the following best describes the effects of this open market operation?
A)Reserves and the money supply increase by less than $100 million.
B)Reserves increase by $100 million and the money supply increases by $100 million.
C)Reserves increase by $100 million and the money supply increases by more than $100 million.
D)Both reserves and the money supply increase by more than $100 million.

Question

Quizplus · Accepted Answer

When the central bank buys $100 million of bonds, reserves increase by $100 million. In a fractional reserve banking system, this increase in reserves allows banks to create more money through lending, leading to a money supply increase of more than $100 million due to the money multiplier effect.

In a Fractional Reserve Banking System with No Excess Reserves