Critical analysis Q16 Suppose that the Federal Reserve purchases a bond for $100,000 from Reggie Rich, who deposits the proceeds in the Manufacturer’s National Bank. Initially, as a result of this bond purchase, the money supply will by. Suppose the required reserve ratio is 25%. As the result of Rich’s deposit, Manufacturer’s Bank will be able to extendin additional loans. As a result of this purchase by the Fed, the maximum increase in the quantity of checkable deposits that could result throughout the entire banking system is

Explanation:

• Initially, As a result of the bond purchase, money supply will increase by $100000.

The reason for the increase in money supply by $100000 is because the federal reserve bought bond of $100000 from Riggie Rich. This is an expansionary policy which will lead to more money in supply.

• As a result of Rich's deposits, the bank will able to give $90000 more in additional loans.

The increase in the additional loans will be calculated by removing the reserve required ratio from the deposit.

= $100000 - (10% × $100000)

= $100000 - $10000

= $90000

• As a result of the purchase by the Federal reserve, the maximum increase in quantity of checkable deposits which could result throughtout the entire banking system will be $1000000.

The increase in checkable deposits will be the change in reserve multiplied by 1/RRR. This will be:

= $100000 x 1/10%

= $100000 × 1/0.1

= $100000 x 10

= $1000000

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