The Federal Reserve conducts a $10million open-market purchase of government bonds. If the required reserve ratio is 10%, what is the largest possible increase in the money supply that could result? Explain. What is the smallest possible increase? Explain.

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Elias Tanner

8 May, 10:41

The Federal Reserve conducts a $10million open-market purchase of government bonds. If the required reserve ratio is 10%, what is the largest possible increase in the money supply that could result? Explain. What is the smallest possible increase? Explain.

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Imani · Answer 1

The maximum amount the money supply could increase is $100 million

The smallest possible increase is $10 million.

Explanation:

When the required reserve ratio is 10 percent or 0.10, then the money multiplier is (1 / required reserve ratio) or (1 / 0.10) = 10.

Now, change in money supply = money multiplier * open market purchase of government bonds.

the Federal Reserve consucts a $10 million open market purchase of government bonds.

As a result of this,

Money Supply increases by (10*$10 million) = $100 million. This is the maximum amount the money supply could increase.

if the bank holds, $10 million as excess reserves, then money supply could increase by as much as $10 million. This is the smallest amount the money supply could increase.

If the required reserve ratio is 10 percent, the largest possible increase in the money supply that could result is $100 million, and the smallest possible increase is $10 million.