In a fractional-reserve banking system with no excess reserves and no currency holdings,if the central bank buys $100 million of bonds,
A) reserves and the money supply increase by less than $100 million.
B) reserves increase by $100 million and the money supply increases by $100 million.
C) reserves increase by $100 million and the money supply increases by more than $100 million.
D) both reserves and the money supply increase by more than $100 million.

Question

Quizplus · Accepted Answer

When the central bank buys $100 million of bonds, it pays the seller with a check, which is deposited in a bank. The bank, which now has an additional deposit of $100 million can lend out a portion of it, keeping only a fraction in reserves. This process continues as the money is deposited and lent out, leading to a multiple expansion of the money supply. The exact increase in the money supply depends on the reserve requirement ratio. Therefore, while the reserves increase by $100 million, the money supply increases by more than $100 million.

In a Fractional-Reserve Banking System with No Excess Reserves and No