Question

Suppose the Federal Reserve wants to increase the money supply by $200. Again, you can assume that banks do not hold excess reserves and that households do not hold currency. If the reserve requirement is 10%, the Fed will use open-market operations to worth of U.S. government bonds?

Answer 1

Answer:

The fed needs to purchase bonds worth $20 from the banks to increase money supply by $200.

Explanation:

The Federal Reserve wants to increase the money supply by $200.

The reserve requirement is 10%.

The fed can increase the money supply by purchasing bonds from commercial banks.  

The money supply will increase by money multiplier times worth of bonds.  

Increase in money supply = $\frac{1}{RR}\ \times\ Worth\ of\ bonds\ purchased$

$200 = $\frac{1}{0.1}\ \times\ Worth\ of\ bonds$

Worth of bonds = $\frac{200}{10}$

Worth of bonds = $20  

So the fed needs to purchase bonds worth $20 from the banks to increase money supply by $200.