Suppose that the Federal Reserve (\"the Fed\") buys $10,000 of U.S. government b

Question

Suppose that the Federal Reserve ("the Fed") buys $10,000 of U.S. government bonds and the required reserve ratio is 0.15. If the assumptions of the simple money multiplier hold, this will_____the money supply by_____Which of the following assumptions is necessary for the simple money multiplier to be applicable? The amount of cash people want to hold doesn't change when the money supply changes. People's marginal propensity to consume does not rise with income. Borrower default rates are stable. If the correct assumption did not hold, the change in the money supply would be_____than you previously found. Which of the following describes why this holds true? If people kept some of the new money as cash rather than depositing it in another bank, this cash could not in turn become a bank loan. If borrower default rates were not stable, then the money creation process would be disrupted. If people's marginal propensity to consume rose with income, they would save less, removing money from the financial system.

Explanation / Answer

1. Increase the money supply

2. Money supply will be: 1/0.15 X $ 10,000 = $ 66,666.67

Money supply increases by 56,666.67 (i.e. 66,666.67 - 10,000)

3. The amount of cash people want to hold doesn't change when the money supply changes.

4. If people kept some of the new money as cash rather than depositing it in another bank, this cash could not in turn become a bank loan.

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