Question

Suppose the Federal Reserve conducts an open market purchase of $100 million by purchasing treasury securities from the Bank of Morrisland. Assume that required reserve ratio is 10%. Also assume that currently the Bank of Morrisland does not hold any excess reserves (i.e. the amount of reserves held by it=10% of its deposits).

1. What would be the effect on the money supply in each of the following situations?
(a) There is only one bank (the Bank of Morrisland) and the bank decides not to make a loan with the excess reserves.
(b) There is only one bank (the Bank of Morrisland), and the bank decides to make a loan for the full amount of its excess reserves. (Assume that once the loan is made, it does not create any further deposits.)
(c) There are many banks, all of which make loans for the full amount of their excess reserves.

Answer 1

a) Fall in money supply

b) No effect on money supply

c) No effect on money supply

Step-by-step explanation:

The increase in money supply usually lowers interest rates, attracting more demand and giving consumers more income, thereby increasing consumption. By buying more goods and increasing production, businesses respond.

Money is viewed as zero in its quantity principle. This does not mean that money supply shifts have no effect. Alternatively, the term "neutral" refers to money supply adjustments having no effect upon one particular variable: real production.