Final answer:
The Federal Reserve's purchase of $7,000 in bonds with a 50% reserve requirement could lead to a potential increase of $14,000 in the money supply. However, the actual impact depends on bank behavior and economic conditions. An increase in the reserve requirement would decrease the money multiplier and thus reduce the potential money supply increase.
Step-by-step explanation:
When the Federal Reserve buys $7,000 worth of bonds and the reserve requirement is 50%, we can use the money multiplier to calculate the potential increase in the money supply. The money multiplier is the inverse of the reserve ratio, so in this case, it will be 1 divided by 0.50, which equals 2.
This means that every dollar of reserves can support $2 of new money creation through the banking system. Therefore, the initial $7,000 purchase of bonds could potentially lead to a maximum increase of $14,000 in the money supply ($7,000 times the money multiplier of 2).
Cautions about relying on the money multiplier include the fact that it depends on banks lending out their excess reserves and on borrowers wanting to take out loans.
Additionally, the money multiplier assumes that banks do not hold excess reserves, which is not always the case. Banks may hold extra reserves due to macroeconomic conditions or government regulations.
If the Federal Reserve changes the reserve requirements or if banks choose to hold more than the required reserves, this would alter the effectiveness of the money multiplier.
If there is an increase in the reserve requirement, the money multiplier will decrease. This will result in a reduced potential for money creation within the economy, as banks will have to hold more reserves and will hence be able to lend out less money. This is a tool used by the Federal Reserve to implement monetary policy.