Assume that the reserve requirement ratio is 12 percent and that the Fed uses open market operations by buying $200 million worth of Treasury securities. Assuming that banks use all funds except required reserves to make loans and that the public does not store any cash, the money supply should ____ by about ____.
A)increase; $200 million
B)increase; $1.67 billion
C)decrease; $200 million
D)decrease; $1.67 billion

Question

Quizplus · Accepted Answer

The $200 million worth of Treasury securities purchased by the Fed will increase the reserves of the banking system by $200 million x (1/0.12) = $1.67 billion (since the reserve requirement ratio is 12%). According to the money multiplier formula (1/required reserve ratio), this increase in reserves should increase the money supply by $1.67 billion x (1/0.12) = $13.9 billion. Therefore, the money supply should increase by about $1.67 billion.

Assume That the Reserve Requirement Ratio Is 12 Percent and That