Question

Assume the required reserve ratio is 10 percent and the FOMC orders an open market sale of $50 million in government securities to banks. Using the oversimplified money multiplier, the money supply could potentially:_____________

a. decrease by $500 million.
b. increase by $100 million.
c. decrease by $100 million.
d. increase by $500 million.

Answer 1

Answer: decrease by $500 million.

Step-by-step explanation:

Money supply is the total amount of money that are in circulation at a particular period of time.

From the question,

Required reserve ratio = 10%

Open market sale = $50 million

Money multiplier = 1/10%

= 1/0.1 = 10

Money supply = $50 million × 10

= $ 500 million

Since the FOMC orders an open market sale, this will lead to the decrease by $500 million.

Answer 2

The correct option is A, decreases by $500 million

Step-by-step explanation:

Selling government securities to banks is more mopping up excess liquidity in the hands of the banks and by implication,in the hands of the public as well.

As a result, the multiplier effect would the cash taken away divided by the required reserve ratio of 10%

Multiplier effect=$50 million/0.10=$500 million decreases in money supply