The Fed makes an open market operation purchase of $200,000.The currency drain is 33.33 percent and the desired reserve ratio is 10 percent.By how much does the quantity of money increase?
A) $800,000
B) $333,333
C) $2,000,000
D) $618,604
E) $465,116

Question

Quizplus · Accepted Answer

First, we need to calculate the effective increase in reserves from the open market operation purchase. The purchase amount is $200,000 and the currency drain is 33.33 percent, so the effective increase in reserves is:

$200,000 x (1 - 0.3333) = $133,340

Next, we can calculate the total increase in the money supply using the money multiplier formula:

Money multiplier = 1 / reserve ratio
Money multiplier = 1 / 0.10
Money multiplier = 10

Total increase in money supply = Money multiplier x Effective increase in reserves
Total increase in money supply = 10 x $133,340
Total increase in money supply = $1,333,400

Therefore, the quantity of money increases by $1,333,400. The closest answer choice is D, which is $618,604 off from the correct answer.

The Fed Makes an Open Market Operation Purchase of $200,000