Assume there is no leakage from the banking system and that all commercial banks
ID: 1227418 • Letter: A
Question
Assume there is no leakage from the banking system and that all commercial banks are loaned up. Suppose the reserve ratio is 25%. When the Fed buys $40m of bonds from the public who then deposit the proceeds into the banking system,
A. bank reserves increase by $40 million and money supply could increase by a maximum of $40 million.
B. bank reserves increase by $40 million and the money supply could increase by a maximum of $160 million.
C. bank reserves decrease by $40 million and money supply could decrease by a maximum of $40 million.
D. bank reserves decrease by $40 million and money supply could decrease by a maximum of $160 million.
Explanation / Answer
Answer) B. bank reserves increase by $40 million and the money supply could increase by a maximum of $160 million.
with the reserve ratio (RR) of 25 percent, the money multiplier, m, will be calculated as:
m = 1/RRm = 1/0.25 = 4.
that any initial deposit( $40 MILLION) will contribute to an expansion in money supply up to 4 times($160 MILLION) its original value.