Answer to Question #51342 in Macroeconomics for oswald

Question

Respond to the following question (one well composed paragraph for each 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

If the Fed sells $5 million worth of bonds to Econobank, then the reserves of the bank will increase.
The money supply in the economy as a whole will increase by 5/0.1 = $50 million, if the reserve requirement is 10%, all payments are made by check, and there is no net drain into currency.
The answer in part b will change and the increase in money supply will be lower if some people involved in the money creation process kept some of their funds as cash.