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22 August, 03:03

Suppose that the reserve requirement for checking deposits is 16 percent and that banks do not hold any excess reserves. If the Fed sells $2 million of government bonds, the economy's reserves by $ million, and the money supply will by $ million.

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  1. 22 August, 04:18
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    Decreases by $2 million; Money supply decreases by $12.5 million

    Explanation:

    Given that,

    Required reserve ratio = 16 percent

    Government bonds sold by Fed = $2 million

    Therefore, the economy's reserve decreases by:

    = Change in money supply * Required reserve ratio

    = $12.5 million * 0.16

    = $2 million.

    Money multiplier = 1 : Required reserve ratio

    = 1 : 0.16

    = 6.25

    Money supply decreases by:

    = Money multiplier * Decline in reserves

    = 6.25 * $2 million

    = $12.5 million
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