If the reserve ratio is 8 percent, banks do not hold excess reserves, and people do not hold currency, then when the Fed purchases $20 million of government bonds, bank reserves
A)increase by $20 million and the money supply eventually increases by $250 million.
B)decrease by $20 million and the money supply eventually increases by $250 million.
C)increase by $20 million and the money supply eventually decreases by $250 million.
D)decrease by $20 million and the money supply eventually decreases by $250 million.

Question

Quizplus · Accepted Answer

When the Fed purchases $20 million of government bonds, bank reserves increase by $20 million. If the reserve ratio is 8%, banks can lend out 92% of their deposits. When this lending cycle continues, the money supply will eventually increase by $250 million (20/0.08). Therefore, the correct answer is A.

If the Reserve Ratio Is 8 Percent, Banks Do Not