The banking system currently has $50 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 to 12.5% and at the same time sells $10 billion dollars of bonds,then by how much does the money supply change?
A)It falls by $20 billion.
B)It falls by $110 billion.
C)It falls by $180 billion.
D)None of the above is correct.

Question

Quizplus · Accepted Answer

The initial money supply is $500 billion (10 times the reserves due to a 10% reserve requirement). Raising the reserve requirement to 12.5% reduces the money multiplier to 8, reducing the money supply to $400 billion. Selling $10 billion in bonds reduces reserves to $40 billion, further reducing the money supply to $320 billion. The total decrease is $180 billion ($500 billion - $320 billion).

The Banking System Currently Has $50 Billion of Reserves,none of Which