Question

Suppose the Federal Reserve wants to reduce the money supply by $1 billion. Assume that the required reserves are 10 percent of checking deposits, banks hold no excess reserves, and households hold no currency. Explain the specific details of this monetary process when reducing the money supply.

Answer 1

Answer:

In order to reduce the money supply by $1 billion, the FED needs to sell $100 million in securities.

Explanation:

The total effect on the money supply is given by: money withdrawn from the economy x money multiplier

money multiplier = 1 / required rate of return = 1 / 10% = 10

effect on the economy = -$100 million x 10 = -$1 billion