Question

Suppose the Federal Reserve wants to increase the money supply by $200. Again, you can assume that banks do not hold excess reserves and that households do not hold currency. If the reserve requirement is 10%, the Fed will use open-market operations to worth of U.S. government bonds?

Answer 1

To increase the money supply by $200 million with a reserve requirement of 10%, the Fed should purchase $20 million in government bonds using open market operations, leveraging the money multiplier effect.

Step-by-step explanation:

If the Federal Reserve wants to increase the money supply by $200 million and banks have a reserve requirement of 10%, the Fed would utilize open market operations accordingly. When the Federal Reserve buys government bonds from banks, banks' reserves increase, allowing them to create more loans. This is due to the money multiplier effect, where every dollar of reserves can support 1/reserve ratio dollars of money supply.

To achieve an increase of $200 million in the money supply, the Federal Reserve should buy a number of bonds that, when the money multiplier is applied, equals the intended increase in the money supply. Given a reserve requirement (reserve ratio) of 10%, or 0.1, the multiplier is 1/0.1 or 10. Thus, the Fed should buy $20 million in bonds ($200 million / 10 = $20 million). This purchase will, through the multiplier effect, increase the money supply by $200 million as banks loan out the new reserves, and these loans circulate and get re-deposited in the banking system.

Answer 2

The fed needs to purchase bonds worth $20 from the banks to increase money supply by $200.

Step-by-step explanation:

The Federal Reserve wants to increase the money supply by $200.

The reserve requirement is 10%.

The fed can increase the money supply by purchasing bonds from commercial banks.

The money supply will increase by money multiplier times worth of bonds.

Increase in money supply =
`(1)/(RR)\ *\ Worth\ of\ bonds\ purchased`

$200 =
`(1)/(0.1)\ *\ Worth\ of\ bonds`

Worth of bonds =
`(200)/(10)`

Worth of bonds = $20

So the fed needs to purchase bonds worth $20 from the banks to increase money supply by $200.