Question

Suppose the reserve ratio is 25 and banks do not hold excess reserves. When the Fed sells 40 million of bonds to the public who then deposits the proceed into the banking system.

Answer 1

If the Fed sells $40 million worth of bonds, it is carrying out a contractionary monetary policy that tries to decrease the money supply.

This transaction should decrease the banks' reserves by $40 million, and the money supply should decrease by a maximum of $160 million (= $40 million x 1/25%) due to the money multiplier.

Money multiplier = 1/25% = 4