If the Fed purchases $1 million worth of securities and the required reserve ratio is 8%, by how much will deposits increase (assuming no change in excess reserves or the public's currency holdings)?

Question

Quizplus · Accepted Answer

The required reserve ratio is 8%, so the initial amount of required reserves is 0.08 x $1 million = $80,000. When the Fed purchases $1 million worth of securities, the bank that sold the securities to the Fed receives $1 million in reserves. This increases the bank's excess reserves by $1 million - $80,000 = $920,000. Using the money multiplier formula (1/required reserve ratio), we can calculate the total increase in deposits as $920,000 x (1/0.08) = $11.5 million. However, we must also add back the initial deposit of $1 million, giving a total increase in deposits of $11.5 million + $1 million = $12.5 million. Therefore, the correct answer is D.

If the Fed Purchases $1 Million Worth of Securities and the Required