Question

Below, you will examine how different open market operations affect the monetary base. You will also use information regarding the value of the money multiplier to identify how these different open market operations affect the money supply. Part 1: Complete the statement below. An open market sale leads the monetary base to (grow, contract), because the Federal Reserve is replacing (money, non-money assets) with (money, non-money assets) in the economy. Part 2: Suppose that the reserve requirement is 8%, and that depository institutions do not hold excess reserves. What is the value of the money multiplier? Part 3: Suppose that the reserve requirement is 8%, and that depository institutions do not hold excess reserves. When an open market sale by the Federal Reserve reduces the monetary base by $50 billion, by how much does the money supply decrease? Part 4: Suppose that the reserve requirement is 10%, and that depository institutions do not hold excess reserves. What is the value of the money multiplier? Part 5: Suppose that the reserve requirement is 10%, and that depository institutions do not hold excess reserves. When an open market sale by the Federal Reserve reduces the monetary base by $50 billion, by how much does the money supply decrease? Part 6: Complete the statement below. Open Market Sales have a (smaller, larger) impact on the money supply when the money multiplier is greater.

Answer 1

Part 1: contract; money; non-money assets
(Open market sale decreases money supply which contracts the money base.)

Part 2: Money multiplier = 1/8% = 12.5

Part 3: Decrease in money supply = Money multiplier*(Reduction in monetary base) = 12.5*(50) = $625 billion

Part 4: Money multiplier = 1/10% = 10

Part 5: Decrease in money supply = Money multiplier*(Reduction in monetary base) = 10*(50) = $500 billion

Part 6: larger
(Larger is the money multiplier, largesr is the impact on the money supply.)