Question

Suppose the Fed purchases $200 million of U.S. securities from the public but the reserve requirement is now only 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 a

Answer 1

$2 billion

Step-by-step explanation:

Let us recall the following statement from the question:

The purchase made by Fed = $200 million of U.S securities from the public

The requirement reserve is = 10%

Now,

let us recall the formula,

(1/r -1)

r = the reserve requirement of 10% or 0.1%

The initial money deposited is = $200 million

By applying the formula (1/r- 1)

The money generated from Fed is = $200 million * (1/0.1-1)

which is

$200 million * 9 = $1.8 billion

The money supply increase or growth = $200 million = 1.8 billion = 2 billion

The total impact on the money supply is $ 2 billion

Answer 2

Therefore the supply of money is directly increased by the purchase of $200 million security and the money creating potential is increased by $2 billion

Step-by-step explanation:

The money created = Initial deposit × (1/r -1),

where r is the reserve requirement = 10% = 0.1 Initial deposit = $200 million.

Therefore: The money created = $200 million × (1/0.1 - 1) = $200 million × 9 = $1.8 billion.

Increase in money supply = $200 million + $1.8 billion = $2 billion

Therefore the supply of money is directly increased by the purchase of $200 million security and the money creating potential is increased by $2 billion