Question

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Assume that the required reserve ratio is 20%. If the Federal Reserve buys $10 million worth of government bonds from the public, the maximum change in the money supply will be: more than 10 million. $2 million. O less than 10 million. o less than 2 million.

Answer 1

Ans. Option a

Change in money supply = Money multiplier * Change in Monetary base

Here, money multiplier = 1/required reserve ratio = 1/0.20 = 5

Change in monetary base = $10 million

=> Change in money supply = 5*10 million = $50 million

Ans. Option b

Money multiplier = 1/required reserve ratio = 1/0.25 = 4

=> Money creating potential = money multiplier * new deposits

=> Money creating potential = 4*40000 = $160000

Ans. Option d

With lower interest rate, the opportunity cost of holding real balances falls, thus, people will be willing to hold more real balances.

Ans. Option a

A decrease in required reserve ratio will mean that banks need to keep less reserves with them freeing up more money that they can lend and thus, increase money supply.

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