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.

Question

Milton

Business

27 January, 03:31

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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Answers (1)

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Yael Medina · Answer 1

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.