Question

assume the federal reserve buys $10 million in bonds. assume the reserve requirement is 5% and banks hold no excess reserves. how much money will be created or destroyed due to this action by the fed?

Answer 1

When the Federal Reserve buys $10 million in bonds, it increases the reserves of the bank that sold the bonds. Assuming a reserve requirement of 5%, the bank is required to hold 5% of its deposits as reserves. Therefore, $500,000 will be destroyed due to this action by the Fed.

Step-by-step explanation:

When the Federal Reserve buys $10 million in bonds, it increases the reserves of the bank that sold the bonds. Assuming a reserve requirement of 5%, the bank is required to hold 5% of its deposits as reserves. Since banks hold no excess reserves, the bank must increase its reserves by $10 million x 5% = $500,000. To restore its required reserves, the bank will reduce its loans by the same amount, $500,000. Therefore, $500,000 will be destroyed due to this action by the Fed.