The banking system currently has $100 billion of reserves,none of which are excess.People hold only deposits and no currency,and the reserve requirement is 10%.If the Fed lowers the reserve requirement ratio to 5% and at the same time buys $10 billion dollars of bonds,then by how much does the money supply change?
A)It rises by $800 billion.
B)It rises by $990 billion.
C)It rises by $1220 billion
D)None of the above is correct.

Question

Quizplus · Accepted Answer

The Fed's purchase of $10 billion of bonds increases the reserves of the banking system by $10 billion. The reduction in the reserve requirement ratio from 10% to 5% means that banks are now required to hold only 5% of their deposits as reserves. This frees up $5 billion of reserves that can be used to make new loans. The combination of the increase in reserves and the decrease in the reserve requirement ratio allows the banking system to create $1220 billion of new money.

The Banking System Currently Has $100 Billion of Reserves,none of Which