The Federal Reserve sells $100 million bonds to Ba nk of America. a. Show the im

Question

The Federal Reserve sells $100 million bonds to Bank of America.

a.Show the immediatechange in the balance sheet of Bank of America due to this transaction

b.Show the immediatechange in the balance sheet of the Federal Reserve due to this transaction

c.Consider the unusual scenario that the public holds no currency and that the banks typically like to hold areserve to deposit ratio of 50%. What is the money multiplier in this case and what will be the change in the money supply as a result of the bond sale?

Explanation / Answer

(a) For Bank of America, Bonds (Assets) increase by $100 million and Reserves (Assets) fall by $100 million. Net effect is no change in Assets, and no change in liabilities.

(b) For Federal Reserve, Bonds (Assets) fall by $100 million and Reserves (Assets) increase by $100 million. Net effect is no change in Assets, and no change in liabilities.

(c)

Money multiplier (MM) = 1 / Reserve-Deposit ratio = 1 / 0.5 = 2

Change in money supply = Bond value x MM = $100 million x 2 = $200 million (fall in money supply)

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