Suppose that the reserve requirement for checking deposits is 12.5 percent and that banks do not hold any excess reserves.

If the Fed sells $2 million of government bonds, the economy’s reserves Increase/Decrease bymillion, and the money supply will Increase/Decrease bymillion.

Now suppose the Fed lowers the reserve requirement to 10 percent, but banks choose to hold another 2.5 percent of deposits as excess reserves.

True or False: The money multiplier will remain unchanged.

a. True
b. False

True or False: As a result, the overall change in the money supply will remain unchanged.

a. True
b. False

1) If the Fed sells $2 million of government bonds, the economy’s reserves Decrease by $2 million, and the money supply will Decrease by $16 million.

2) The money multiplier will remain unchanged. True

3) As a result, the overall change in the money supply will remain unchanged. True

Explanation:

1.) We have the reserve requirement for checking deposits as 12.5% with banks not holding any excess reserves.

To calculate Money Multiplier:

Money Multiplier = = = 8

If the Fed sells $2 million of bonds, reserves will decrease by $2 million and the money supply will decrease by 8 x $2 million = $16 million.

2) and 3) Now the Fed lowers the reserve requirement to 10 percent, but banks choose to hold another 2.5 percent of deposits as excess reserves.

To calculate Money Multiplier:

Money Multiplier = = = 8

Money multiplier is 8 same as in 1) Therefore the statements: "The money multiplier will remain unchanged" and "As a result, the overall change in the money supply will remain unchanged" are both True.