Assume that the required reserve ratio is 25 percent. If the Federal Reserve sells $120 million in government securities to the general public, the money supply will immediately:

Question

Quizplus · Accepted Answer

When the Federal Reserve sells $120 million in government securities to the general public, banks will have $120 million less in reserves. This will lead to a contraction in the money supply because banks will have less money to lend out. The initial decrease in the money supply will be equal to the amount of the sale, which in this case is $120 million. However, because the required reserve ratio is 25 percent, banks will need to reduce their lending by four times the initial sale in order to maintain the required reserves. This means that the maximum decrease in the money supply will be $480 million (4 x $120 million). Therefore, the correct answer is A.

Assume That the Required Reserve Ratio Is 25 Percent