Assume that the currency-deposit ratio is 0.2 and the reserve-deposit ratio is 0.1.The Federal Reserve carries out open-market operations,purchasing $1 million worth of bonds from banks.This action will increase the money supply by
A)$1 million.
B)$2 million.
C)$3 million.
D)$4 million.

Question

Quizplus · Accepted Answer

The money multiplier formula is 1 / (reserve-deposit ratio + currency-deposit ratio). Plugging in the given values, the multiplier is 1 / (0.1 + 0.2) = 1 / 0.3 = 3.33. Therefore, a $1 million open-market purchase by the Federal Reserve will increase the money supply by $1 million * 3.33 = $3.33 million, which is closest to $4 million.

Assume That the Currency-Deposit Ratio Is 0