Question

If the Fed sells securities to commercial banks, there is no money multiplier effect. T of F

Answer 1

Answer- TRUE.

If Federal sells securities to commercial banks, there is no money multiplier effect. Money multiplier tells us by how many times the money supply will increase as a result of an initial deposit made. Money multiplier= 1/RR. RR is the required reserve ratio. Hence, money multiplier depends upon the required reserve ratio. A change in the required reserve ratio changes the money multiplier.

When Federal sells securities to commercial banks, commercial banks pay to the Federal by drawing cheque on their accounts. As such the cash holdings of commercial banks will reduce and cash reserves of bank will decrease. Hence, selling of securities by the Federal will change the cash reserves of bank. As required reserve ratio does not change, money multiplier will not change. Hence, there is no money multiplier effect.

False is INCORRECT because selling of securities will not effect money multiplier. When Federal will sell securities to commercial banks, Banks will make payment to the Federal by drawing cheque on their accounts. This will reduce the cash holdings of the commercial banks and their cash reserves will be effected. There is no effect on money multiplier.