Question

Assume that the reserve requirement is 20 percent. Also assume that banks do not hold excess reserves and there is no cash held by the public. The Fed decides that it wants to expand the money supply by $40 million. a. If the Fed is using open-market operations, will it buy or sell bonds? b. What quantity of bonds does the Fed need to buy or sell to accomplish the goal? Explain your reasoning.

Answer 1

Answer:

a) An expansionary monetary policy which increases the economy's money supply, requires that the FED purchases securities. This way the FED will inject money into the economy.

b) we must first determine the money multiplier = 1 / reserve ratio = 1 / 20% = 5. If the FED wants to increase the money supply by $40 million, it must inject $40 million / 5 = $8 million. This way the $8 million will turn into $40 million.