Question

Suppose the Fed conducts an open market sale of $50 million in government securities. If the required reserve ratio is 20%, what is the maximum change in the money supply? Assume that banks try not to hold excess reserves and there is no currency withdrawal from the banking system.

Answer 1

Answer:

The maximum change in the money supply is 250 million

Explanation:

In this question, we are asked to calculate the maximum change in money supply given that the required reserve ratio is 20%.

Firstly, we need to calculate the multiplier in this case.

The multiplier in this case can be calculated by dividing 1 by the required reserve ratio

Mathematically, multiplier = 1/required reserve ratio = 1/0.2 = 5(kindly note that 20/100 = 0.2)

Now, we move on to calculate the maximum change in the money supply.

This would be equal to multiplier * value of open market sale = 5 * 50 million = 250 million

Therefore, the maximum change in the money supply is 250 million

Answer 2

Answer:

$250 million

Explanation:

we first get the money multiplier  which is

= 1/ reserve ratio

= 1 / 20% = 1 / 0.2 = 5

therefore the money multiplier  = 5

Assume the banks try not to hold excess reserves and also no currency withdrawals form the banking system the Multiplier will be valid to find the maximum change in the money supply

which is calculated as

= money multiplier * value of government security

= 5 * $50 million

= $250 million