Question

Assume there is no leakage from the banking system and that all commercial banks are loaned up. The required reserve ratio is 16%. If the Fed sells $5 million worth of government securities to the public, the change In the money supply will be:_______. A) -$31.25 million. B) -$21 million. C) -$16 million. D) -$11.75 million.

Answer 1

The correct answer is A, the change in money supply will be -$31.25 million

Step-by-step explanation:

When Fed sold government securities to the public worth $5 million, that means Fed is withdrawing $5 million from the circulation judging from shallow perspective.

But in actual terms,Fed is withdrawing $5 million from the economy that has the potential to yield $5/16% i.e $31.25 million in the long run if left in the economy and allowed to be exchanged freely between commercial banks and the public.

Hence, amount withdrawn is the main issue of concern , is the money-making potential inherent in the amount that is relevant.