Suppose an economy uses a monetary system of checkable deposits only and it has a required reserve ratio of 20%. If the central bank in this economy conducts an open market purchase of $5 million of Treasury bills, this will potentially _____ the money supply by _____.

Question

Quizplus · Accepted Answer

An open market purchase of $5 million increases reserves by $5 million. With a reserve ratio of 20%, the money multiplier is 1/0.20 = 5. Thus, the potential increase in the money supply is $5 million * 5 = $25 million.

Suppose an Economy Uses a Monetary System of Checkable Deposits