The reserve ratio is 2 percent. If the Fed buys $1 million of U.S. government securities and the check is deposited in Bank A, but Bank A increases its vault cash by the entire amount, then the money supply

Question

Quizplus · Accepted Answer

When the Fed buys government securities worth $1 million, Bank A's reserves increase by $1 million. Since the reserve ratio is 2 percent, Bank A can lend out $980,000 ($1 million - $20,000). If Bank A chooses to increase its vault cash by the entire $1 million, it does not lend out any funds, but the money supply still increases by $1 million, which is equal to the amount of reserves injected into the banking system by the Fed. Therefore, the correct answer is C.

The Reserve Ratio Is 2 Percent