Question

Suppose the reserve requirement in the united states is 20% - Suppose the federal reserve wants to increase the money supply by 100 billion. the federal reserve should decrease the reserve requirement by ___.

Answer 1

Answer:

Reserve requirement = 20% or 0.250

Simple money multiplier = 1/Reserve Ratio = 1/0.2 = 5

Note that,

Increase in money supply = Increase in total reserves * Simple money multiplier

$100 Billion = Increase in total reserves * 5

Increase in total reserves = $20 billion

This means that the federal reserve should decrease the reserve requirement by purchasing $20 billion worth of US government bonds from banks, which will lead to increase of $100 billion in money supply.