Question

Suppose the Fed decides it needs to pursue an expansionary policy. Assume people hold no cash, the reserve requirement is 20 percent, and there are no excess reserves. How would the Fed increase the money supply by $1 million through open market operations? O A. Because the current money multiplier is 5, the Fed would sell $200000 worth of bonds, increasing the monetary base and so increasing the money supply by $1000000 B. Because the current money multiplier is 5, the Fed would sell $200000 worth of bonds, decreasing the monetary base and so increasing the money supply by $1000000. C. Because the current money multiplier is 5, the Fed would buy $200000 worth of bonds, increasing the monetary base and so increasing the money supply by $1000000. D. Because the current money multiplier is 5, the Fed would buy $200000 worth of bonds, decreasing the monetary base and so increasing the money supply by $1000000.

Answer 1

The money multiplier is given as 1/reserve requirements = 1/.2 = 5

So, in order to increase the money supply the FED will have to buy the bond from the banks and public. This will given money to the banks and public.

Hence, FED would buy $200,000 worth of bonds. As $200,000*5= $1,000,000. This will increase the monetary base.

So, the correct option is option C.