Suppose the money supply (as measured by checkable deposits) is currently S750 b

Question

Suppose the money supply (as measured by checkable deposits) is currently S750 billion. The required reserve ratio is 30%. Banks hold S225 billion in reserves. Thus, there are no excess reserves. The Federal Reserve wants to decrease the money supply by $50 billion, to $700 billion. It could do so through open market operations or by changing the required reseve ratio. Assune for this question that you can use the simple deposit expansion multiplier If the Federal Reserve wants to decrease the money supply using open market operations, it should worth of U.S. government bonds.

Explanation / Answer

Deposit multiplier = 1 / Required reserve ratio = 1 / 0.3 = 10 / 3 (= 3.33).

When Fed wants to decrease money supply, it should sell in open market $15 billion (= $50 billion / 3.33) worth US government bonds.

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