Suppose that the reserve requirement for checking deposits is 10 percent and that banks do not hold any excess reserves. If the Fed sells $1 million of government bonds, what is the effect on the economy's reserves and money supply? Now suppose the Fed lowers the reserve requirement to 5 percent, but banks choose to hold another 5 percent of deposits as excess reserves. Why might banks do so? What is the overall change in the money multiplier and the money supply as a result of these actions?

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Krish Fox

23 April, 22:57

Suppose that the reserve requirement for checking deposits is 10 percent and that banks do not hold any excess reserves. If the Fed sells $1 million of government bonds, what is the effect on the economy's reserves and money supply? Now suppose the Fed lowers the reserve requirement to 5 percent, but banks choose to hold another 5 percent of deposits as excess reserves. Why might banks do so? What is the overall change in the money multiplier and the money supply as a result of these actions?

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Landen Walls · Answer 1

Take a look to the following explanation

Explanation:

Reserve ratio, 10%=0.1

Money multiplier=1/reserve ratio=1/0.1=10

If feds sells 1million$ bond the economy reserves increases by 1 million$ and money supply decrease by 10 million $ (1*money multiplier).

If fed changes RR to 5% but banks choose to hold another, 5 percent as excess reserve, then on aggregate actual reserve ratio will be 10%. So money multiplier would remain same, 10 and so the money supply