Assume the required reserve ratio is 20 percent. If the Federal Reserve buys $80 million in government securities from the public, then the money supply will immediately:
A) increase by $80 million, and the maximum money-lending potential of the commercial banking system will increase by $80 million.
B) increase by $80 million, but the maximum money-lending potential of the commercial banking system will decrease by $80 million.
C) increase by $80 million, and the maximum money-lending potential of the commercial banking system will increase by $400 million.
D) decrease because the securities are an asset to the commercial banks and a liability to the Federal Reserve.

Question

Quizplus · Accepted Answer

When the Federal Reserve buys $80 million in government securities, the money supply increases by that amount. With a 20% reserve ratio, the banking system can lend out 5 times the initial increase, leading to a potential increase of $400 million in the money supply.

Assume the Required Reserve Ratio Is 20 Percent