Question

Suppose the reserve requirement is 20%. The Fed wants to increase money supply by $100 billion. It should decrease reserve requirements by $____________billion.

a) $500
b) $50
c) $10
d) $1000

Answer 1

To increase the money supply by $100 billion with a 20% reserve requirement, the Fed would need to increase reserves by $20 billion; however, none of the choices provided are correct.

Step-by-step explanation:

The question pertains to the implementation of monetary policy via reserve requirements set by the Federal Reserve (the Fed). To increase the money supply by $100 billion when the reserve requirement is 20%, the Fed could lower the reserve requirement. The reserve requirement dictates the portion of depositor's balances that banks must have on hand as cash in their vaults or in their reserve accounts at the Fed. With a 20% requirement, every $1 increase in reserves supports $5 in deposits (100% / 20% = 5), which is known as the money multiplier.

Therefore, to increase the money supply by $100 billion, banks' reserves need to increase by $20 billion ($100 billion / 5 = $20 billion). However, none of the provided choices are correct since they do not include the option that corresponds to the $20 billion increase needed.