Question

Answer the following questions: a) If a bank depositor deposits $1,000 of currency to his checking account, what happens to reserves, checkable deposits, and the monetary base? b) If the Fed buys bonds worth $2 million from the First National Bank, what happens to reserves and the monetary base? Use T-accounts to explain your answer c) If the Fed sells $2 million of bonds to Irving the Investor, who pays for the bonds with a check, what happens to reserves and the monetary base? Use T- accounts to explain your answer d) The Fed sells $100 million of bonds from the public and also increases the required reserve ratio. What will happen to the money supply?

Answer 1

A). - Reserves will decrease by $1000.

      - Checkable deposits will decrease by $1000.

     - The monetary base will be unchanged, since reserves decrease by the same amount as currency increases.

B).

The activity increases both the reserves as well as the monetary base by $2 million.

Federal Reserve System
Assets	Liabilities
Securities                                               +$ 2m	Reserves                                               +$ 2m

First National Bank
Assets	Liabilities
Securities                                               -$ 2m
Reserves                                                +$ 2m

C).

The activity reduces Fed’s holdings of securities by $1 million, and reduces the Bank/check balance by $1 million. This reduces the monetary base by $1 million, although reserves remain the same.

Federal Reserve System
Assets	Liabilities
Securities                                               -$ 1m	Bank/Check                                            -$ 1m

Irving The Investor
Assets	Liabilities
Securities                                               +$ 1m
Bank/Check                                            -$ 1m

D).

- The Fed’s sale of $100 million of bonds reduces the monetary base by the same amount.

- The raising of the required reserve ratio reduces the amount of multiple deposits expansion and reduces the money multiplier.

So, the two policy actions lead to a decrease in the money supply.