The banking system currently has $10 billion of reserves,none of which are excess.People hold only deposits and no currency,and the reserve requirement is 10 percent.If the Fed raises the reserve requirement to 20 percent and at the same time buys $1 billion of bonds,then by how much does the money supply change?
A) It falls by $45 billion.
B) It falls by $52 billion.
C) It falls by $55 billion.
D) None of the above is correct.

Question

Quizplus · Accepted Answer

Initially, with a 10% reserve requirement, the money multiplier is 10, leading to a money supply of $100 billion. Raising the reserve requirement to 20% reduces the money multiplier to 5, decreasing the money supply to $50 billion. The Fed's $1 billion bond purchase increases reserves by $1 billion, allowing for a $5 billion increase in the money supply. Thus, the net change is a decrease of $45 billion ($50 billion - $100 billion + $5 billion).

The Banking System Currently Has $10 Billion of Reserves,none of Which