The banking system currently has $50 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 12.5 percent and at the same time sells $10 billion of bonds,then by how much does the money supply change?

Question

Quizplus · Accepted Answer

First, we need to calculate the current amount of deposits in the banking system, which is:
$50 billion / 0.1 = $500 billion

When the reserve requirement is raised to 12.5 percent, banks need to hold $62.5 billion in reserves ($500 billion x 0.125). This means that the required reserves have increased by $12.5 billion ($62.5 billion - $50 billion).

Since banks do not have excess reserves, they need to decrease their loans and deposits by $12.5 billion to meet the new reserve requirement. This reduces the money supply by $125 billion (since the money supply is 10 times the amount of reserves).

Additionally, the Fed is selling $10 billion of bonds, which reduces the amount of reserves in the banking system by this amount. Since the reserve ratio is now 12.5 percent, the money supply decreases by $80 billion (since $10 billion in reserves supports $80 billion in deposits).

Overall, the money supply falls by $125 billion + $80 billion = $205 billion. None of the answer choices reflects this amount, so C is the closest option.

The Banking System Currently Has $50 Billion of Reserves,none of Which