Suppose the reserve ratio is 10 percent, and banks do not hold excess reserves. Suppose the Bank of Canada sells $10 million of bonds to the public. Which of the following best describes the effects of this open market operation?
A)Bank reserves increase by $1 million, and the money supply eventually increases by $10 million.
B)Bank reserves increase by $10 million, and the money supply eventually increases by $100 million.
C)Bank reserves decrease by $1 million, and the money supply eventually increases by $10 million.
D)Bank reserves decrease by $10 million, and the money supply eventually decreases by $100 million.

Question

Quizplus · Accepted Answer

When the Bank of Canada sells $10 million of bonds to the public, bank reserves decrease by $10 million. With a reserve ratio of 10%, the money supply eventually decreases by $100 million due to the money multiplier effect.

Suppose the Reserve Ratio Is 10 Percent, and Banks Do