Suppose the Fed sells $10 million in government securities to a commercial bank.If the required reserve ratio is 0.2,what is the maximum amount by which checkable deposits in the banking system can change? (Hint: Compare what the banking system might have done if it had loaned at every opportunity; also include the initial transaction with the Fed.)

Question

Quizplus · Accepted Answer

When the Fed sells $10 million in government securities to a commercial bank, the bank's reserves decrease by $10 million. Given a required reserve ratio of 0.2, this means that the bank's checkable deposits can potentially decrease by up to $50 million.

This is because a commercial bank can lend out excess reserves, and each time a loan is made, it creates new deposits in the banking system (through the process of deposit multiplication). Assuming the banking system fully lends out these excess reserves, the initial decrease in reserves of $10 million could lead to a decrease in checkable deposits of up to $50 million.

Therefore, the maximum amount by which checkable deposits in the banking system can change is -$50,000,000.

Suppose the Fed Sells $10 Million in Government Securities to a Commercial