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Asked Dec 9, 2019
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Expert Answer

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...

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