If the Federal Reserve conducts a $10 million open-market sale and the reserve requirement is 20%, the monetary base will:

Question

Quizplus · Accepted Answer

When the Federal Reserve conducts an open-market sale of $10 million, it sells government securities to banks or other financial institutions. As a result, the banks' reserves decrease by $10 million, which reduces the total monetary base by the same amount. Since the reserve requirement is 20%, this means that the multiplier effect of the open-market sale is 1/0.2 = 5. Therefore, the total decrease in the money supply is $10 million x 5 = $50 million. Hence, the monetary base decreases by $10 million.

If the Federal Reserve Conducts a $10 Million Open-Market Sale