Question

The Federal Reserve wants to increase the money supply by increasing the lending potential of commercial banks by $300 billion. It plans to use open-market operations to accomplish this goal. The current reserve requirement for commercial banks is 25 percent. Instructions: Enter your answer as a whole number.

 

a. Will the Fed want to buy or sell government securities if sales or purchases of government securities are the only instrument used in the open-market operations?

The Fed will want to _(Sell/Buy). a total of $ _billion in government securities.

 

b. What other option could the Fed pursue-rather than permanently transferring the ownership of securities to achieve its goal?

The Fed could use some amount of (repos/reverse repos) to effectively (borrow money/lend money to). commercial banks

Answer 1

Answer to the question no. 1:

The Fed is looking to increase the money supply by $300. For this, the Fed will buy government securities a total of $75.

Explanation: We have that the RRR=25%=0.25. So, the Money Multiplier (MM) will be:

This mean that if the Fed increases the monetary base by 1 unit the money supply in the economy will increase by 4 units.

To increase the money supply Fed will buy government securities. Given the RRR=25%, to increase the money supply by $300 the Fed will buy securities worth of $75 as:

Answer to the question no. 2:

The Fed could use some amount of Repos to effectively lend money to Commerial Banks.

Explanation: We know that the Repo rate is the rate at which the comercial banks borrow from the Fed and the Reverse repo is the rate at which the Fed borrows from the commercial banks. To increase the money supply, the Fed will reduce the Repo and hence the commercial banks will tend to borrow more form Fed and lent to the borrowers. This will increase the money supply in the economy.