The reserve requirement is 4%, banks hold no excess reserves and people hold no currency. If the Fed sells $10,000 of bonds what happens to the money supply?
A)it increases by $250,000
B)it increases by $200,000
C)it decreases by $200,000
D)it decreases by $250,000

Question

Quizplus · Accepted Answer

When the Fed sells $10,000 of bonds, banks will need to pay the Fed for the bonds. Since reserve requirement is 4%, the banks will need to reduce their checkable deposits and therefore the money supply decreases. The money supply will decrease by a multiple of the initial sale amount, which is 1/0.04 x $10,000 = $250,000. Therefore, the correct answer is D) it decreases by $250,000.

The Reserve Requirement Is 4%, Banks Hold No Excess Reserves