Question

50.What happens to checkable deposits in the banking system when the Fed sells​ $2 million of bonds to the First National​ Bank, assuming that the required reserve ratio on checkable deposits is​ 10%, banks do not hold any excess​ reserves, and the​ public's holdings of currency do not​ change?

A.

Checkable deposits increase by​ $20 million.

B.

Checkable deposits decline by​ $2 million.

C.

Checkable deposits decline by​ $20 million.

Answer 1

Question 50

When Fed sells the bonds then it leads to decrease in reserves with banks.

When reserves with banks decreases, the money creation process decreases and leads to decrease in checkable deposits.

Amount of bonds sold = $2 million

Reserve requirement = 10% or 0.10

Money multiplier = 1/reserve requirement

Money multiplier = 1/0.10 = 10

Calculate the decrease in checkable deposits -

Decrease in checkable deposits = Amount of bonds sold × Money multiplier

Decrease in checkable deposits = $2 million × 10 = $20 million

Thus,

The checkable deposits will decline by $20 million.

Hence, the correct answer is the option (c).