Final answer:
The claim that a $2 billion purchase by the Fed will expand the money supply by $20 billion is false, as the actual expansion would be $8 billion due to a reserve ratio of 10% and people holding 15% of money as cash.
Step-by-step explanation:
The student asks whether it's true that if the Federal Reserve buys $2 billion in Treasury bills/bonds with a 10% reserve ratio and individuals hold 15% of their money as cash, the money supply will expand by $20 billion. This statement is false. When the Fed buys Treasury bonds, the initial injection of money leads to an expansion of the money supply through the banking system. However, the amount of money created is not a simple tenfold increase of the initial transaction but is instead based on the reserve ratio and the behavior of individual money holders.
The money multiplier formula is 1 / (reserve ratio + % of money held as cash) which would be 1 / (0.10 + 0.15) = 1 / 0.25 = 4 in this scenario. Thus, the total money supply expansion would be 4 times the initial injection, which results in an expansion of $8 billion, not $20 billion. This is because individuals holding cash outside the banking system do not allow those funds to be multiplied through the banking process as reserves do. The correct answer is b) False. When the Federal Reserve buys Treasury bills/bonds, it increases the money supply. However, the expansion of the money supply is not equal to the amount the Fed buys. The money supply expansion is determined by the money multiplier, which is influenced by the reserve ratio and the amount of money individuals hold in cash.
In this case, if the Federal Reserve buys $2 billion Treasury bills/bonds, the money supply will not necessarily expand by $20 billion. The actual expansion will depend on the money multiplier, which is influenced by factors like the reserve ratio and individual's cash holdings. Therefore, the statement that the money supply would expand by $20 billion is false.