Question

Answer the question on the assumption that the legal reserve ratio is 20 percent. Suppose that the Fed sells $500 of government securities to commercial banks (paid for out of commercial bank reserves) and buys $500 of securities from individuals, who deposit the cash in checking accounts. As a result of the given transactions, reserves in the banking system will:

A. remain unchanged.
B. rise by $100
C. rise bi $1000
D. fall by $100

Answer 1

Answer:

D. fall by $100

Explanation:

fall by $100

When fed sells $500 to commercial banks, banks keep 20% of deposit with themselves which is $100. Rest $400 will be loaned out in the economy. When fed buys $500 of securities, $500 is pulled out from the economy. Hence the total effect = $400 - $500 = - $100. Thus, in total there will be a fall in $100