If the Fed buys $10 million of government securities when the desired reserve ratio is 20 percent and the currency drain ratio is 5 percent,the quantity of money
A)increases by $42 million.
B)increases by $50 million.
C)decreases by $42 million.
D)decreases by $50 million.
E)increases by $7.5 million.

Question

Quizplus · Accepted Answer

The money multiplier is calculated as 1 / (desired reserve ratio + currency drain ratio) = 1 / (0.20 + 0.05) = 4. The increase in the money supply is the money multiplier times the amount of securities purchased: 4 * $10 million = $40 million. However, the currency drain ratio slightly reduces this, leading to an increase of approximately $42 million.

If the Fed Buys $10 Million of Government Securities When