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2. Assume that the reserve requirement is 3 percent. All other equal, will the money supply...

2. Assume that the reserve requirement is 3 percent. All other equal, will the money supply expand more if the Federal Reserve buys $3,000 worth of bonds or if someone deposits in a bank $3,000 that he had been hiding in his cookie jar? If one creates more, how much more does it create? Explain your reasoning.

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Answer #1

Money supply will expand more if Fed buys $3,000 worth bonds.

Fed's open market purchase will increase the M1 and M2 measures of quantity of money. But depositing $3,000 in bank, which was earlier saved as currency in circulation with public, will decrease currency in circulation by $3,000 and increase checkable deposits by $3,000, so net effect on M1 or M2 will be zero since both currency and checkable deposits are components of both M1 and M2.

Increase in money supply = Bond purchased / Required reserves ratio = $3,000 / 0.03 = $100,000

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