Question

If the reserve ratio is 15 percent, and banks do not hold excess reserves, and people hold only deposits and no currency, then when the Fed sells $25.5 million worth of bonds to the public, bank reserves

A. Increase by $25.5 million and the money supply eventually increases by $382.5 million.
B. Increase by $25.5 million and the money supply eventually increases by $170 million.
A. Decrease by $25.5 million and the money supply eventually increases by $382.5 million.
A. Decrease by $25.5 million and the money supply eventually increases by $170 million.

Answer 1

The money supply decreases by $25.5 million and money supply decreases by $170 million.

Step-by-step explanation:

The reserve ratio is 15%.

The reserve sells bonds worth $25.5 million to the public.

This will cause a reduction of $25.5 million reserves as banks will need to pay Fed for the bonds.

The money supply will change by

=
`(1)/(reserve\ ratio) *\ change\ in\ reserves`

=
`(1)/(0.15)\ *\ -\$ 25.5\ million`

=
`6.67\ *\ -\$ 25.5\ million`

= - $170 milion

So, the money supply will decrease by $170 million.