Question

price level increases by 0.2 percent for every $100 billion increase in the money supply, by how much might prices rise if the Fed increases total reserves by $100 billion and the reserve requirement is 0.10?

Answer 1

If the Fed increases total reserves by $100 billion and the reserve requirement is 0.10, we can expect prices to rise by approximately 2%.

How to solve for the amount that prices would rise

Increase in reserves = $100 billion

Reserve requirement = 0.10

The increase in the money supply can be calculated as follows:

Increase in money supply = Increase in reserves / Reserve requirement

Increase in money supply = $100 billion / 0.10

Increase in money supply = $1,000 billion

The expected increase in the price level can be calculated as follows:

Price level increase per $100 billion = 0.2%

Price level increase = (Change in money supply / $100 billion) x Price level increase per $100 billion

Price level increase = ($1,000 billion / $100 billion) x 0.2%

Price level increase = 2%

Therefore, if the Fed increases total reserves by $100 billion and the reserve requirement is 0.10, we can expect prices to rise by approximately 2%.