Question

Assume that the required reserve ratio for the commercial banks is 25 percent. If the Federal Reserve Banks buy $3 billion in government securities from the non-bank securities dealers, then as a result of this transaction, the lending ability of the commercial banking system will increase by:
A. $4.5 billion B. $9 billion C. $12 billion D. $15 billion

Answer 1

Answer: $12 billion

Explanation:

Given that,

Required reserve ratio (rr) =  25 percent

Fed purchases government securities = $3 billion

Money multiplier = $\frac{1}{rr}$

                            = $\frac{1}{0.25}$

                            = 4

Lending ability of the commercial banking system will increase by:

= Money multiplier × Increase in Fed purchases

= 4 × $3 billion

= $12 billion