Question

Assume that the banking system is loaned up and that any open-market purchase by the Fed directly increases reserves in the banks. If the required reserve ratio is 0, by how much could the money supply expand if the Fed purchased $2 billion worth of bonds?

Answer 1

Solution:

First, derive the money multiplier:

Money multiplier = $\frac{1}{r} = \frac{1}{0} = 0$

Change in money supply = Change in money reserves $\times$ the multiplier

Change in money supply = 2 $\times$ 0 = 0

The money supply will not expand or change if the required reserve ratio is equal to zero.