The Fed purchases $1 million of U.S.government securities from First Bank.The desired reserve ratio is 10 percent, the currency drain is zero, and banks loan all excess reserves.The money multiplier is equal to

Question

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The money multiplier (MM) is calculated as MM = 1/required reserve ratio. Since the desired reserve ratio is 10 percent, the MM is 1/0.1 = 10.

When the Fed purchases $1 million of government securities, this increases the reserves of First Bank by $1 million. Since the desired reserve ratio is 10 percent, First Bank must hold $100,000 of reserves against the $1 million deposit. This leaves $900,000 in excess reserves that can be loaned out.

Assuming all banks in the economy loan out their excess reserves, the money supply will increase by a total of $9 million (MM x $900,000 excess reserves). Therefore, the money multiplier in this scenario is 10.0.

The Fed Purchases $1 Million of U