Question

The banking system currently has $50 billion of reserves, none of which are excess. People hold only deposits and no currency, and the reserve requirement is 10percent. If the Fed raises the reserve requirement to 12.5 percent and at the same time sells $10 billion worth of bonds, then by how much does the money supplychange?

Answer 1

If the bank holds $50 billion in non-excess reserves as the 10% requirement, then it is currently accountable for $500 billion worth of deposits. The $450billion not required to be held in reserves is loaned out completely to others. In this situation, the money supply is $500 billion + the $450 billionloaned out = $950 billion

If the Fed raises the reserve requirement to 12.5% and sells $10 billion worth of bonds, then people only have $490 billion to deposit; a reserve of 12.5%would require the bank to hold $61.25 billion in reserve, in effect only allowing $428.75 billion to be loaned out. The money supply is then $490 billion +$428.75 billion = $918.75 billion

The money supply decreases by $31.25 billion after these federal measures.

Hope this helps!