Question

Suppose the Fed buys $100,000 of U.S. Treasury bonds from Bill Gates. If the reserve requirement is 10 percent, the currency holdings of the public are unchanged, and banks have zero excess reserves both before and after the transaction, the total impact on the money supply will be ____________

Answer 1

Answer: an increase by $1,000,000.

Explanation: As part of its monetary policy the Fed decides the reserve requirements for banks which has an effect on multiplier effect and ultimately on money supply.

The money multiplier effect is a reciprocal of the reserve requirement, thus, when the reserve requirement is 10%, the multiplier effect is 10 [1 / (10/100)]

The reserve requirement is currently 10%, and the Federal Reserve makes an open market purchase of $100,000 worth of US treasury bonds from Bill Gates. The maximum amount the money supply could increase because of this purchase is $1,000,000.

This is gotten by determining the multiplier is 1/10%, which is 10.

Then applying: Change in Money Supply = Change in Reserves * Money Multiplier, the maximum change in the money supply is:

$100,000 * 10 = $1,000,000

Answer 2

an increase by $1,000,000.

Step-by-step explanation:

Suppose the Fed buys $100,000 of U.S. Treasury bonds from Bill Gates. If the reserve requirement is 10 percent, the currency holdings of the public are unchanged, and banks have zero excess reserves both before and after the transaction, the total impact on the money supply will be an increase by $1,000,000.