Suppose the Federal Reserve buys $50 million in Treasury bills from commercial banks. If the reserve ratio is 10%, the monetary supply might eventually _____ by _____.

Question

Quizplus · Accepted Answer

When the Federal Reserve buys $50 million in Treasury bills from commercial banks, the reserves of the banks will increase by $50 million. However, due to the 10% reserve ratio, the banks are required to hold only $5 million as reserves and can lend out the remaining $45 million. This $45 million will be deposited in other banks and can be used as reserves by those banks to lend further, resulting in a multiplier effect. Using the formula for the money multiplier, which is the reciprocal of the reserve ratio (1/0.1 = 10), we can calculate that the initial $50 million injection can eventually lead to an increase in the monetary supply by $500 million ($50 million x 10). Therefore, option A is correct.

Suppose the Federal Reserve Buys $50 Million in Treasury Bills