If the reserve ratio is 10 percent, banks do not hold excess reserves, people hold only deposits and no currency, then when the Fed sells $10 million worth of bonds to the public, bank reserves
A)increase by $1 million and the money supply eventually increases by $10 million.
B)increase by $10 million and the money supply eventually increases by $100 million.
C)decrease by $1 million and the money supply eventually increases by $10 million.
D)decrease by $10 million and the money supply eventually decreases by $100 million.

Question

Quizplus · Accepted Answer

When the Fed sells $10 million worth of bonds, bank reserves decrease by $10 million. With a reserve ratio of 10%, the money supply decreases by a multiple of the change in reserves, leading to a $100 million decrease in the money supply.

If the Reserve Ratio Is 10 Percent, Banks Do Not