Question

During the financial crisis, banks excess reserves [beyond what is required by regulatory reserve requirements] exploded. If the Federal Reserve Bank of New York purchased $1 billion in U.S. Treasury Bills in this environment and the reserve requirement is 20%, then the change in the total money supply will be approximately:

Answer 1

Answer:

an increase of a bit less than $5 billion.

Explanation:

When the Federal reserve purchases treasury bill, it is known as an expansionary monetary policy

Expansionary monetary policy : these are polices taken in order to increase money supply. When money supply increases, aggregate demand increases. reducing interest rate and open market purchase are ways of carrying out expansionary monetary policy

Change in the total value of money supply is determined by the money multiplier

Money multiplier = amount purchased / reserve ratio

Reserve ratio is the percentage of deposits that is required of commercial banks to keep as reserves. The lower the ratio, the higher the increase in money supply

1 billion / 0.2 = $5 billion

there would be an increase of about 5 billion in money supply