The banking system currently has $10 billion of reserves,none of which are excess.People hold only deposits and no currency,and the reserve requirement is 10%.If the Fed raises the reserve requirement ratio to 20% and at the same time buys $1 billion dollars of bonds,then by how much does the money supply change?
A)It falls by $45 billion.
B)It falls by $52 billion.
C)It falls by $55 billion.
D)None of the above is correct.

Question

Quizplus · Accepted Answer

The initial money supply is $100 billion (10% reserve requirement on $10 billion reserves). Raising the reserve requirement to 20% reduces the money multiplier from 10 to 5, decreasing the money supply to $50 billion. The Fed's $1 billion bond purchase increases reserves to $11 billion, allowing for a $55 billion money supply. The net change is a $45 billion decrease.

The Banking System Currently Has $10 Billion of Reserves,none of Which