Final answer:
A central bank can increase the money supply by purchasing bonds from banks like Happy Bank in open market operations, leading banks to loan out their excess reserves. This action expands the money supply through the lending process and the money multiplier effect. An example bank with a leverage ratio of 10 would have $600 million in assets if it had a net worth of $60 million.
Step-by-step explanation:
To understand how a central bank can increase the money supply using open market operations, we can look at the balance sheet of Happy Bank. Initially, Happy Bank has $460 million in assets, which include reserves, bonds, and loans, and $400 million in liabilities in the form of deposits. When the central bank carries out an open market purchase of $20 million in bonds from Happy Bank, the bank's reserves increase by the same amount, leading Happy Bank to loan out this extra $20 million as it maintains its desired reserve level of $40 million.
This action by Happy Bank leads to an increase in loans, thereby expanding the money supply through the lending process. As those loans are deposited and re-loaned across various banks, the effect on the money supply is magnified due to the money multiplier effect. Therefore, through open market operations, a central bank can effectively increase the amount of money circulating within the economy.
An example of a bank balance sheet with a leverage ratio of 10 implies that for every $1 of equity, the bank has $10 in assets. This could mean, for instance, if Happy Bank has a net worth of $60 million, it could have $600 million in assets, provided other regulatory and operational conditions are met.