Suppose the Fed purchases $100 million of U.S. securities from the public. If the reserve requirement is 20 percent, the currency holdings of the public are unchanged, and banks have zero excess reserves both before and after the transaction, the total impact on the money supply will be a
A) $100 million decrease in the money supply.
B) $100 million increase in the money supply.
C) $200 million increase in the money supply.
D) $500 million increase in the money supply.

Question

Quizplus · Accepted Answer

When the Fed purchases $100 million in securities, it increases bank reserves by $100 million. With a reserve requirement of 20%, banks can lend out 80% of their deposits. This creates a money multiplier effect, calculated as 1/reserve requirement (1/0.20 = 5). Therefore, the total increase in the money supply is $100 million * 5 = $500 million.

Suppose the Fed Purchases $100 Million of U