Assume the Fed purchases $5,000 worth of U.S.Treasury bonds from Bill Gates, who promptly deposits the money in Microsoft Rules National Bank.Assuming that the required reserve ratio is 25 percent and banks keep zero excess reserves, then the money supply will:

Question

Quizplus · Accepted Answer

When the Fed purchases Treasury bonds from Bill Gates, the Fed transfers $5,000 to Mr. Gates, which he deposits in Microsoft Rules National Bank. Since the required reserve ratio is 25%, the bank is required to hold $1,250 ($5,000 x 0.25) in reserves and may loan out the remaining $3,750. However, the borrower of the $3,750 will deposit it back into the banking system, and the process will continue. The end result is that the money supply increases by $20,000 ($5,000/0.25), which is the same as the initial deposit multiplied by the reciprocal of the required reserve ratio.

Assume the Fed Purchases $5,000 Worth of U