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5 June, 06:30

The Fed conducts a $10 million open-market purchase of government bonds. If the required reserve ratio is 10 percent, what are the largest and smallest possible increases in the money supply that could result? Explain.

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  1. 5 June, 07:02
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    1) Largest possible increase is $100 million

    2) Smallest possible increase is $10 million

    Explanation:

    1) In order to find the largest possible increase in the money supply we need to find the money multiplier. The formula for money multiplier is 1/reserve ratio so the money multiplier is 1/0.1 = 10. So if the fed conducts an open market purchase of $10 million the maximum amount that the money supply can increase is million * multiplier = 10 million * 10 = $100 million, however this will only be the case if the bank decides to keep 0 excess reserves, if the bank decides to keep any excess reserves the money supply increase will be less than a $100 million.

    2) The lowest amount that the money supply can increase by is $10 million because if the bank decides to keep all of this money in reserve and loan none of this than the money supply will only increase by $10 million.
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