Question

Congratulations! You have been appointed adviser to the Federal Reserve Bank. a. The Federal Open Market Committee decides that it must increase the money supply by $50. Committee members tell you the reserve ratio is 0.2. They ask you what directive they should give to the open market desk. You tell them, being as specific as possible, using the money multiplier. The Fed should buy Correct$ 250 250 Incorrect worth of government bonds. b. They ask you for two other ways they could have achieved the same end. You tell them. Instructions: In order to receive full credit, you must make a selection for each option. For correct answer(s), click the box once to place a check mark. For incorrect answer(s), click twice to empty the box. Increase the discount rate checked Reduce the discount rate checked Lower the reserve requirement checked Raise the reserve requirement checked Raise taxes checked Lower taxes checked

Answer 1

a. Buy $10 worth of Government Bonds.

b. ⇒Reduce the discount rate

⇒Lower the reserve requirement

Step-by-step explanation:

a. By buying bonds, the Government can introduce money into the economy. The question is how much bonds should be bought.

Amount to buy(monetary base) = Target Money Supply/Multiplier

The Multiplier is used to find out how much money will be supplied in the economy given a $1 increase in the monetary base.

= 1 / Reserve Ratio

= 1 / 0.2

= 5

Amount to buy =
`(50)/(5)`

= $10 worth of Government bonds

b.

• Reduce the discount rate

The Discount Rate is the rate at which the Fed loans money out to commercial banks. If this rate is reduced, commercial banks will be encouraged to borrow more the Fed from which they will then be able loan out to the public thus increasing the amount of money in the Economy.

• Lower the reserve requirement

The Reserve Requirement refers to how much banks are supposed to hold in reserve and not loan out by law. By reducing this requirement, banks will have more money to loan out and when they do, the amount of money in the Economy will rise.