Suppose checking deposits increase by $6,000 after all rounds of the money-creation process when the Fed buys $1,200 worth of U.S.government securities.This implies that the maximum value of the required reserve ratio is:

A) 5.
B) 0.75.
C) 0.2.
D) 1.2.
E) 1.0.

Question

Amber Bracy · Accepted Answer

Final Answer : C, Explanation :  First, we need to understand the process of money creation when the Fed buys government securities:1. The Fed buys $1,200 worth of government securities from a bank.2. The bank receives $1,200 in reserves from the Fed, increasing its total reserves.3. The bank can then make loans and create new checking deposits based on the required reserve ratio.4. Assuming a required reserve ratio of 20% (which means the bank must hold 20% of its deposits as reserves), the bank can create new checking deposits equal to $6,000 (the increase in checking deposits) / (1 - 0.2) = $7,500.5. The total increase in the money supply is $7,500 - $1,200 = $6,300.Now, we can solve for the maximum value of the required reserve ratio by using the same process and assuming different values for the required reserve ratio:1. If the required reserve ratio is 100%, then the bank cannot create any new checking deposits and the increase in the money supply would only be $1,200. This is less than the actual increase of $6,000, so the required reserve ratio must be less than 100%.2. If the required reserve ratio is 50%, then the bank can create new checking deposits equal to $6,000 / (1 - 0.5) = $12,000. This is greater than the actual increase of $6,000, so the required reserve ratio must be greater than 50%.3. If the required reserve ratio is 25%, then the bank can create new checking deposits equal to $6,000 / (1 - 0.25) = $8,000. This is still greater than the actual increase of $6,000, so the required reserve ratio must be greater than 25%.4. If the required reserve ratio is 20%, then the bank can create new checking deposits equal to $6,000 / (1 - 0.2) = $7,500. This is equal to the actual increase of $6,000, so the required reserve ratio must be 20% or less.5. If the required reserve ratio is 15%, then the bank can create new checking deposits equal to $6,000 / (1 - 0.15) = $7,059. This is still greater than the actual increase of $6,000, so the required reserve ratio must be less than 15%.Therefore, the maximum value of the required reserve ratio is 20%, which is choice C.

Suppose checking deposits increase by $6,000 after all rounds of the money-creation process when the Fed buys $1,200 worth of U.S.government securities.This implies that the maximum value of the required reserve ratio is:

A) 5.
B) 0.75.
C) 0.2.
D) 1.2.
E) 1.0.

Definitions

Learning Objectives

Learning Objectives

Related questions

Suppose checking deposits increase by $6,000 after all rounds of the money-creation process when the Fed buys $1,200 worth of U.S.government securities.This implies that the maximum value of the required reserve ratio is:A) 5.B) 0.75.C) 0.2.D) 1.2.E) 1.0.

Definitions

Learning Objectives

Learning Objectives

Related questions

Suppose checking deposits increase by $6,000 after all rounds of the money-creation process when the Fed buys $1,200 worth of U.S.government securities.This implies that the maximum value of the required reserve ratio is:

A) 5.
B) 0.75.
C) 0.2.
D) 1.2.
E) 1.0.