Suppose that the Fed undertakes an open market sale,selling $1 million worth of securities to a bank.If the required reserve ratio is 8%,checkable deposits (or the money supply),would _______________ by ________________ million,assuming that there are no cash leakages and that banks hold zero excess reserves.
A) rise; $12.5
B) decline; $8
C) decline; $12.5
D) rise; $8

Question

Quizplus · Accepted Answer

When the Fed sells $1 million worth of securities to a bank and the required reserve ratio is 8%, the bank's reserves will decrease by $1 million x 0.08 = $80,000. As the bank's reserves decrease, its ability to create checkable deposits, or lend out money, also decreases. Assuming no cash leakages and zero excess reserves, the money supply will decline by the amount that the bank's reserves decreased, which is $80,000 / 0.08 = $1,000,000. Therefore, the correct answer is C, a decline in the money supply by $12.5 million.

Suppose That the Fed Undertakes an Open Market Sale,selling $1