Question

If the reserve ratio is 15 percent, and banks do not hold excess reserves, and people hold only deposits and no currency, then when the Fed sells $25.5 million worth of bonds to the public, bank reserves
A. Increase by $25.5 million and the money supply eventually increases by $382.5 million.
B. Increase by $25.5 million and the money supply eventually increases by $170 million.
A. Decrease by $25.5 million and the money supply eventually increases by $382.5 million.
A. Decrease by $25.5 million and the money supply eventually increases by $170 million.

Answer 1

Answer:

The money supply decreases by $25.5 million and money supply decreases by $170 million.

Explanation:

The reserve ratio is 15%.

The reserve sells bonds worth $25.5 million to the public.

This will cause a reduction of $25.5 million reserves as banks will need to pay  Fed for the bonds.

The money supply will change by

= $\frac{1}{reserve\ ratio} \times\ change\ in\ reserves$

= $\frac{1}{0.15}\ \times\ -\ 25.5\ million$

= $6.67\ \times\ -\ 25.5\ million$

= - $170 milion

So, the money supply will decrease by $170 million.