Suppose the money supply (as measured by checkable deposits) is currently $700 b

Question

Suppose the money supply (as measured by checkable deposits) is currently $700 billion. The required reserve ratio is 25%. Banks hold $175 billion in reserves, so there are no excess reserves. The Federal Reserve (ldquo the Fed rdquo) wants to Increase the money supply by $44 billon, to $744 billion. It could do this through open-market operations or by changing the required reserve ratio. Assume for this question that you can use the simple money multiplier. If the Fed wants to increase the money supply using open-market operations, it should billion worth of U.S. government bonds. If the Fed wants to Increase the money supply by adjusting the required reserve ratio, it should the required reserve ratio.

Explanation / Answer

If Fed wants to increase money supply using open market operations, it should purchase $11 billion (= $44 billion x 25%) worth bonds.

If Fed wants to increase money supply by adjusting required reserve ratio, it should decrease required reserve ratio.

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