Answer to Question #40453 in Macroeconomics for leo

Question

Suppose the Fed sells $5 million worth of bonds to Econobank.

What happens to the reserves of the bank?
What happens to the money supply in the economy as a whole if the reserve requirement is 10%, all payments are made by check, and there is no net drain into currency?
How would your answer in part b be affected if you knew that some people involved in the money creation process kept some of their funds as cash?

Answer 1

Suppose the Fed sells $5 million worth of bonds to Econobank.
What happens to the reserves of the bank?
What happens to the money supply in the economy as a whole if the reserve requirement is 10%, all payments are made by check, and there is no net drain into currency?
How would your answer in part b be affected if you knew that some people involved in the money creation process kept some of their funds as cash?

Solution
If the Fed sells $5 million worth of bonds to Econobank reserves of the bank will decrease, as it pays its own money on balance for these bonds.
If the reserve requirement is 10%, all payments are made by check, and there is no net drain into currency, the money supply in the economy as a whole would not change,
because $5 million is taken out from the money supply after the bank paid for Fed bonds, but the bonds is also a kind of money.
If some people involved in the money creation process kept some of their funds as cash, the money supply would increase, as this money can be given as credit money.