Question

Suppose the Federal Reserves' purchase of government bonds results in a $14,000 increase in the excess reserves of a particular bank. What would be the applicable reserve requirement for the whole banking system to be able to expand the money supply by $700,000?

a) 5 percent
b)2 percent
c)50 percent
d)20 percent
e)25 percent

Answer 1

The applicable reserve requirement for the whole banking system to be able to expand the money supply by $700,000 is 2 percent.

Step-by-step explanation:

To determine the applicable reserve requirement for the whole banking system to be able to expand the money supply by $700,000, we need to calculate the increase in excess reserves due to the Federal Reserve's bond purchase. Since the purchase resulted in a $14,000 increase in excess reserves for a particular bank, we can calculate the total increase in excess reserves by dividing the desired money supply expansion by the required reserve ratio.

The reserve requirement for the whole banking system can be calculated using the formula:

1. Excess Reserves = Total Reserves - Required Reserves
2. Required Reserves = Deposits x Reserve Ratio
3. Desired Money Supply Expansion = Excess Reserves x (1 / Reserve Ratio)

In this case, we have the following information:

• Desired Money Supply Expansion = $700,000
• Excess Reserves increase for the particular bank = $14,000

To calculate the applicable reserve requirement, we rearrange the formula to solve for the reserve ratio:

Reserve Ratio = Excess Reserves / Desired Money Supply Expansion

Substituting the given values:

Reserve Ratio = $14,000 / $700,000 = 0.02 = 2%

Therefore, the applicable reserve requirement for the whole banking system to be able to expand the money supply by $700,000 is 2 percent.