The Federal Reserve sells $100 million bonds to Bank of America. a.Show the imme

Question

The Federal Reserve sells $100 million bonds to Bank of America.

a.Show the immediate change in the balance sheet of Bank of America due to this transaction

b.Show the immediate change in the balance sheet of the Federal Reserve due to this transaction

c.Consider the unusual scenario that the public holds no currency and that the banks typically like to hold a reserve to deposit ratio of 50%. What is the money multiplier in this case and what will be the change in the money supply as a result of the bond sale?

Explanation / Answer

a. In the Balance sheet of Bank of America,there will be an increase in Asset in the form of bonds(investments) by $100 million.. At the same time Cash and deposits will decrease by the same amount, since the Bonds are bought.

b.In the Balance sheet of Federal Reserves,there will be a decrease in Asset in the form of bonds(investments) by $100 million.. At the same time Cash and deposits will increase by the same amount, since the Bonds are sold for cash.

c. Money Multiplier= 1/r,where 'r' is the reserve ratio. Using this formula, the Money multiplier is 2 in this case.

The change in Money supply= Change in Reserves*Money Multiplier.

= $50 million*2= $100 million.

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