Asked by Pyper Mortenson on Jun 17, 2024
Verified
Assume that there are no excess reserves in the banking system when the reserve requirement is 20%.The purchase of $10,000 in U.S.government securities by the Fed from Academy National Bank has the potential to ultimately increase the money supply by:
A) $2,000.
B) $8,000.
C) $10,000.
D) $20,000.
E) $50,000.
Reserve Requirement
This is the minimum amount of funds that a bank must hold in reserve against deposits made by customers, a critical tool in monetary policy.
Money Supply
The total amount of money available in an economy at a specific time, including cash and various types of deposits.
Government Securities
Financial instruments issued by the government to finance its expenditures, offering a return to the investors.
- Describe the utilization of the money multiplier theory in predicting variations in the money supply as a result of actions taken by the central bank.
Verified Answer
MG
Mariah GareisJun 24, 2024
Final Answer :
E
Explanation :
When the Federal Reserve purchases $10,000 in U.S. government securities from a bank, it increases the bank's reserves by that amount. With a reserve requirement of 20%, this means the bank must keep 20% of deposits as reserves and can lend out 80%. The initial $10,000 can be lent out, redeposited, and lent out again in a process called the money multiplier effect. The formula for the maximum potential increase in the money supply is 1/reserve requirement ratio. Therefore, 1/0.20 = 5. Thus, the $10,000 can potentially increase the money supply by 5 times that amount, or $50,000.
Learning Objectives
- Describe the utilization of the money multiplier theory in predicting variations in the money supply as a result of actions taken by the central bank.