Question

The balance sheet below reflects Zee Bank after its purchase of $65 million in government securities from the Fed. Assume a required reserve ratio of 10%, that banks hold no excess reserves, and that all currency is deposited into the banking system.
Assets Liabilites and net worth Reserves $15 million Liabilities: Checking Deposits $150 million Loans $275 million Net Worth $205 Treasuries $65 million

How did the purchase of $65 million in government securities from the Fed affect the money supply? Choose one:

A. The money supply increased by $65 million.
B. The money supply increased by $650 million.
C. The money supply decreased by $650 million.
D. The money supply decreased by $65 million.

Answer 1

Answer:

Option (C) is correct.

Explanation:

The money multiplier = 1 ÷ reserve ratio

                                    = 1 ÷ 0.1

                                    = 10

If a bank purchases $65 million of government securities from the Fed then this will reduce the money supply in the economy because the money from the bank is going.

The decrease in money supply:

= purchase amount × money multiplier

= 65 × 10

= 650 million