Question

Assume that the following balance sheet portrays the state of the banking system. The banks currently have no excess reserves. 

What is the required reserve ratio? 

25% 10% 40% 5%

Suppose that the Federal Reserve (the "Fed") buys $10 million of bonds from a bond dealer, who immediately deposits the funds in her checking account. What is the initial impact of this transaction? 

The banking system's holdings of securities fall by $10 million, and the banking system's total reserves rise by $10 million. 

Checkable deposits rise by $10 million, and the banking system's holdings of securities rise by $10 million. 

Checkable deposits rise by $10 million, and the banking system's total reserves rise by $10 million. 

The banking system's holdings of securities rise by $10 million, and the banking system's total reserves fall by $10 million. 

As a result of the Fed's purchase of $10 million of securities, checkable deposits in the banking system can potentially _______ by as much as _______ 

increase/decrease

13.33m/40m/160m/10m

Answer 1

Required reserve is determined as a certain percentage of liabilities.

Required reserve ratio = x% of total liability

$ 40 billion = x% of $ 160 billion

Required reserve ratio = 25%

2. The money is deposited by bond holder in their checking account. Thus, this transaction increases the checkable deposits by $ 10 million and the reserve too increases by an equal amount.

Option 3. Checkable deposit rises by $ 10 million, and the banking systems total reserve increases by $ 10 million.

3. As a result of the Fed's purchase of $ 10 million of securities, checkable deposit in the banking system can potentially increase by as much as $ 40 million.

Since, Required reserve ratio = 25%

thus, simple multiplier = 1/RRR

Multiplier = 4

Potential change in checkable deposit = $10 million * 4 = $ 40 million.

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