Assume that there is a 25 percent reserve ratio and that the Federal Reserve buys $4 billion worth of government securities. If the securities are purchased from the nonbank public, this action has the potential to increase money supply by a maximum of1. $16 billion, but only by $14 billion if the securities are purchased directly from commercial banks. 2. $14 billion, but by $16 billion if the securities are purchased directly from commercial banks. 3. $16 billion, and also by $16 billion if the securities are purchased directly from commercial banks. 4. $14 billion, and by $20 billion if the securities are purchased directly from commercial banks.

Question

Dale Stout

Business

29 May, 12:22

Assume that there is a 25 percent reserve ratio and that the Federal Reserve buys $4 billion worth of government securities. If the securities are purchased from the nonbank public, this action has the potential to increase money supply by a maximum of1. $16 billion, but only by $14 billion if the securities are purchased directly from commercial banks. 2. $14 billion, but by $16 billion if the securities are purchased directly from commercial banks. 3. $16 billion, and also by $16 billion if the securities are purchased directly from commercial banks. 4. $14 billion, and by $20 billion if the securities are purchased directly from commercial banks.

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Answers (1)

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Ibrahim Cuevas · Answer 1

2) $14 billion, but by $16 billion if the securities are purchased directly from commercial banks.

Explanation:

When the FED purchases securities, it is increasing the money supply.

The total potential increase in the money supply (when securities are purchased from commercial banks) is calculated by multiplying the amount of money injected into the economy times the money multiplier:

money multiplier = 1 / r = 1 / 25% = 4

$4 billion x 4 = $16 billion

If the securities are not purchased from commercial banks, the increase in the money supply will be smaller since the public will always hold a certain amount of money.