If the reserve requirement for banks is fixed at 10% and the Fed wishes to decrease the money supply by $500 billion,what type of open market operation should the Fed undertake?
A) Sell $55.56 billion in government securities
B) Purchase $55.56 billion in government securities
C) Sell $50.00 billion in government securities
D) Purchase $50.00 billion in government securities

Question

Quizplus · Accepted Answer

When the Fed sells government securities, it takes money out of circulation, effectively decreasing the money supply. With a 10% reserve requirement, every dollar the Fed removes from the banking system results in a tenfold decrease in the money supply due to the money multiplier effect. Therefore, to decrease the money supply by $500 billion, the Fed needs to sell $50 billion in government securities. However, the correct calculation to achieve a $500 billion reduction through open market operations, considering the multiplier effect, is not provided in the options directly. The closest option, given the intent to decrease the money supply, is to sell government securities, but the specific amounts listed ($55.56 billion and $50.00 billion) do not directly correspond to the correct multiplier calculation based on the information provided. The correct approach involves selling securities, but a precise calculation to reach exactly $500 billion reduction with a 10% reserve requirement would typically involve selling $50 billion, not the amounts listed. Thus, the principle behind the correct answer is selling securities, but the provided options do not accurately reflect the standard multiplier calculation.

If the Reserve Requirement for Banks Is Fixed at 10