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 increases reserves, allowing banks to lend more. With a 20% reserve ratio, the money multiplier is 1/0.2 = 5. Thus, a $5 million purchase can increase the money supply by $5 million * 5 = $25 million.

Suppose an Economy Uses a Monetary System of Checkable Deposits