Homework Answers
The reserve ratio is 25%
Fed buys $200 million worth of government securities.
It is given that securities are purchased directly from public.
Assume that securities are purchased directly from commercial banks, then given the reserve ratio of 25%, the potential increase in the bank lending is given as:
(1/25%) of $200 million = 4*$200 million = $800 million
But, since in actual, the securities are purchased directly from public which directly increases the money supply by $200 million.
Hence, the potential increase in the bank lending, given that securities are purchased directly from public by Fed is $800 million - $200 million = $600 million
Hence, when securities are purchased by Fed directly from public, the bank lending would increase by a maximum of $600 million.
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