Question

Assuming that the Federal Reserve Banks sell $40 million in government securities to commercial banks and the reserve ratio is 20 percent, then the effect will be to reduce

a.Excess reserves by $8 million
b.Excess reserves by $200 million
c.The money supply by potentially $200 million
d.The money supply by potentially $400 million

Answer 1

Selling $40 million in government securities to commercial banks when the reserve ratio is 20 percent will reduce the excess reserves by $8 million.

Step-by-step explanation:

When the Federal Reserve Banks sell $40 million in government securities to commercial banks and the reserve ratio is 20 percent, the effect will be to reduce the excess reserves by $8 million. This is because the banks are required to hold a certain percentage of their deposits as reserves, and selling the securities would decrease their excess reserves by the corresponding amount. It does not directly affect the money supply.