Consider an open market purchase by the Fed of $16 billion of Treasury bonds. Wh
ID: 2495625 • Letter: C
Question
Consider an open market purchase by the Fed of $16 billion of Treasury bonds. What is the impact of the purchase on the bank from which the Fed bought the securities? Compute the impact on M1 assuming that: (1) the required reserve ratio is 5 percent; (2) the bank does not wish to hold excess reserves; and (3) the public does not wish to hold currency. The bank’s securities by $16 billion and its reserves by $16 billion. Assuming that the required reserve ratio is 5 percent, banks do not want to hold excess reserves, and the public does not wish to hold currency,
the simple deposit multiplier will be?
so the value of deposits (and M1) will rise by how many Billion?
Explanation / Answer
An open market purchase by the Fed of $1.6 billion of treasury bills would mean that the bank would recieve money.Open market operations involve the buying and selling of government debt by the Fed.
Open market operations and changes in the reserve requirement change bank reserves and the monetary base. if the Fed buys $16 million in bonds from a bank, the bank's reserves increase by $16 million, money which the bank will desire to loan out. The $16 million increase in bank reserves yields an equivalent increase in the monetary base. By creating an additional $16 million in loans, the recipients of the loans will spend the money on goods and services. And through the multiplier process, when the bank makes loans, the money supply will increase by a multiple of the $16 million. The money supply will increase by an amount equal to the change in the money base ($16 million) times the money multiplier. If the reserve requirement is 5% and the money multiplier equals 20 (1/.10), the potential increase in the money supply will equal $320 million ($16 million x 20) assuming the bank doesn't want to keep any excess reserves.