Question
1 views
check_circle

Step 1

a) Current reserves = \$10 billion

Reserve requirement = 10%

Therefore, deposit = (reserves *100)/ Reserve requirement = 10*100 / 10 = \$100 billion

Deposits = \$100 billion

New Reserve requirement = 12.5%

Therefore, new reserves should be = 12.5% of deposits = 0.125 * 100 billion = \$12.5 billion

So, extra \$2.5 billion needs to be kept as deposits which means money supply reduces by \$2.5 billion

Fed buys \$1 billion worth bonds that means \$1 billion money supply is increasing in the economy as Fed buys the bonds and in return pay \$1 billion for it.

The money supply changes by = -\$2.5 billion + \$1 billion = -1.5 billion

Thus, the money supply decreases by \$1.5 billion which has been explained how.

Step 2

b)

Current reserves = \$50 billion

Reserve requirement = 10%

Therefore, deposit = (reserves *100)/ Reserve requirement = 50*100 / 10 = \$500 billion

Deposits = \$500 billion

New Reserve requirement = 12.5%

Therefore, new reserves should be = 12.5% of deposits = 0.125 * 500 billion = \$62.5 billion

So, extra \$12.5 billion needs to be kept as deposits which means money supply reduces by \$12.5 billion

Fed se...

### Want to see the full answer?

See Solution

#### Want to see this answer and more?

Solutions are written by subject experts who are available 24/7. Questions are typically answered within 1 hour.*

See Solution
*Response times may vary by subject and question.
Tagged in