Below is the T-account for Country One Bank, the only bank in a small island nation. In addition to the demand

Question

Below is the T-account for Country One Bank, the only bank in a small island nation. In addition to the demand deposits of $100,000, citizens hold $20,000 in coins and currency. Assume that demand deposits and currency are the only forms of money. Citizens also hold $40,000 of government bonds. These are not considered to be part of the money supply. The reserve ratio is 10%.

The central bank in this country undertakes open market operations and purchases $20,000 of bonds.

Use this information to answer the following questions.

Assets Liabilities

Reserves $10,000 Deposits $100,000

Loans $90,000

Assuming that the commercial bank does not change its reserve ratio and citizens continue to hold only $20,000 in coins and currency, what is the resulting change in the money supply after the money multiplier process is complete?

A. The money supply decreases by $200,000.

B. The money supply increases by $20,000.

Answer 1

To purchase bonds central bank should spend money (give it to public) - so this means that money supply should increase by $20'000 multiplied by money-multiplier. Money multiplier equals reciprocal of reserve requirement. Reserve requirement is given by "Reserves" divided by "Deposits" so:

Reserve requirement =10'000/100'000 =10%

Money multiplier = 1/10%=1/0.1=10

Monetary base increase =$ +20'000

Money supply increase =$ 20'000*10 = +$200'000

Unfortunatelly right answer is not in your list (nor "A" neither "B").