Question

Suppose the Federal Reserve (Fed) decides the current money supply of $2.1 trillion is too low, and that an increase of $400 billion is necessary. What tool can the Fed use to accomplish this increase? Assume the current reserve ratio is 0.1 a. Sell govenment securities b. Buy govemment securities c. Increase the reserve ratio d. Increase the interest paid on bank reserves

Answer 1

Answer:

b. Buy government securities

Explanation:

By buying government securities, the FED will engage in an expansionary monetary policy that should increase the money supply to its desired level. Theoretically, since the reserve ratio is 10%, the money multiplier is 1/10% = 10, so the increase in the money supply should be accomplished by purchasing $40 billion in securities.

This can also be done by lowering the reserve ratio.