Question

Assume that the required reserve ratio is 10 percent. If the central bank wants to increase the money supply by $20 billion, what is the specific open-market operation (type and minimum value) that the central bank needs to conduct?

Answer 1

The central bank needs to conduct an open-market purchase of government securities worth at least $2 billion to increase the money supply by $20 billion, assuming a required reserve ratio of 10 percent.

Step-by-step explanation:

To increase the money supply by $20 billion, the central bank needs to conduct an open-market purchase of government securities.

The minimum value of the open-market purchase can be calculated using the money multiplier formula:

Money multiplier = 1 / Required reserve ratio

Money multiplier = 1 / 0.1 = 10

The money multiplier tells us the total amount of money that can be created for each dollar of reserves held by banks.

To increase the money supply by $20 billion, the central bank needs to increase reserves by:

Reserve increase = Desired increase in money supply / Money multiplier

Reserve increase = $20 billion / 10 = $2 billion

Therefore, the central bank needs to conduct an open-market purchase of government securities worth at least $2 billion to increase the money supply by $20 billion, assuming a required reserve ratio of 10 percent.