Question

Assume that the reserve requirement is 5 percent. All other things being equal, will the money supply expand more if the Fed buys $2,000 worth of bonds or if someone deposits in a bank $2,000 that she had been hiding in her cookie jar? If one creates more, how much more does it create? Support your thinking.

Answer 1

Answer: See explanation

Step-by-step explanation:

Based on the information given in the question, the reserve ratio is given as 5%, then the money multiplier will be:

= 1 / reserve requirement

= 1/5%

= 1 / 0.05

= 20.

Therefore, the money multiplier will increase by 20.

Then, the Money supply will be calculated as:

= amount x money multiplier

= 2000 x 20

= 40000

Therefore, the increase in the money supply will be $40000.

In this case, if the FED purchases $2000 worth of bonds, it'll expand the money supply more.