If the reserve ratio is 10%, and banks do not hold excess reserves, when the Fed purchases $10 million of government bonds, bank reservesA) increase by $10 million and the money supply could eventually increase by $10 million. B) decrease by $10 million and the money supply could eventually decrease by $100 million. C) increase by $10 million and the money supply could eventually increase by $100 million. D) decrease by $10 million and the money supply could eventually decrease by $10 million

Question

Mischief

Business

8 September, 12:25

If the reserve ratio is 10%, and banks do not hold excess reserves, when the Fed purchases $10 million of government bonds, bank reservesA) increase by $10 million and the money supply could eventually increase by $10 million. B) decrease by $10 million and the money supply could eventually decrease by $100 million. C) increase by $10 million and the money supply could eventually increase by $100 million. D) decrease by $10 million and the money supply could eventually decrease by $10 million

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Answers (1)

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Breean · Answer 1

Option (C) is correct.

Explanation:

Given that,

Reserve ratio = 10%

Fed purchases government bonds = $10 million

The money multiplier:

= 1 : reserve ratio

= 1 : 0.10

= 10.

Increase in Money supply:

= Multiplier * Government purchases

= 10 * 10

= 100.

Therefore, the bank reserves increase by $10 million and the money supply could eventually increase by $100 million.