Assume that money lent by a bank is deposited into the banking system. The reserve ratio...

Assume that money lent by a bank is deposited into the banking system. The reserve ratio is 20% and the Fed sells $100 million of bonds on the open market. Using this information, answer the following questions.

How would the M1 money supply change immediately (and by how much) as a result of the sale of bonds?

As a result of the $100 million sale of bonds on the open market, calculate the maximum change in the money supply over time.

Solutions

Expert Solution

Answer -

M1 supply includes the deposits. Hence with the sale of bonds , M1 supply will decrease by $ 100 million.

Reserve ratio = 20 %

Money multiplier = 1/reserve ratio

= 1/0.20

= 5

Change in money supply = 100*5

= $ 500 million.

Money supply will decrease by $ 500 million.

Rahul Sunny answered 2 years ago

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