Assume that the reserve requirement is 20%. Also assume that banks do not hold excess reserves

and there is no cash held by the public. The Federal Reserve decides that it wants to expand the
money supply by $40 million.
a. If the Fed is using open-market operations, will it buy or sell bonds?
b. What quantity of bonds does the Fed need to buy or sell to accomplish the goal? Explain your
reasoning.

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To answer these questions, let's break down the information provided step by step.

1. The reserve requirement is 20%: This means that banks must hold 20% of their deposits as reserves. The remaining 80% can be loaned out or invested.

2. Banks do not hold excess reserves: This means that banks are fully utilizing their reserves and not keeping any extra.

3. There is no cash held by the public: This means that all the money in circulation is held in bank deposits.

4. The Federal Reserve wants to expand the money supply by $40 million: By increasing the money supply, the Fed wants to inject an additional $40 million into the economy.

a. If the Fed is using open-market operations, will it buy or sell bonds?

In open-market operations, the Fed buys or sells government securities (bonds) to influence the money supply. To expand the money supply, the Fed needs to inject more money into the economy. Therefore, it will buy bonds.

b. What quantity of bonds does the Fed need to buy or sell to accomplish the goal? Explain your reasoning.

To determine the quantity of bonds the Fed needs to buy, we can use the concept of the money multiplier. The money multiplier shows how much the money supply can increase when new reserves are injected into the banking system.

In this scenario, the reserve requirement is 20%. This means that for every $1 of new reserves injected into the banking system, the money supply can expand by $1 / 0.20 = $5.

To expand the money supply by $40 million, we need to find how much reserves the banking system needs. We can use the formula:

Reserves = Money Supply / Money Multiplier

Reserves = $40 million / $5 = $8 million

Since the Fed wants to buy bonds and inject new reserves into the banking system, it needs to buy $8 million worth of bonds to achieve its goal.

In summary, the Federal Reserve will buy bonds through open-market operations and needs to buy $8 million worth of bonds to accomplish its goal of expanding the money supply by $40 million.

sell bonds