Question

Assume that the reserve requirement is 10%. All other things being equal, will the money supply expand MORE if the Fed buys $1,000 worth of bonds OR if someone deposits in a bank $1,000 that she had been hiding under her mattress? If one situation creates more money, how much more does it create? Explain your answer briefly (no more than 2-3 short sentences).

Answer 1

Solution:

The reserve ratio is 10%.

Money multiplier = $\frac{1}{reserve requirement }$ = $\frac{1}{0.10}$  = 10.

So, the money multiplier increases by 10.

Money supply = amount x money multiplier = 1,000 x 10 = 10000

Therefore, because any certain items are equivalent, the rise in the currency supply is 10000 dollars.

When the FED sells 1,000 million worth of debt, this would further increase the monetary market, as the investments are fresh funds and the income from the bank is now used in the money supply.