Assume that the reserve requirement ratio is 12 percent and that the Fed uses open market operations by purchasing $200 million worth of Treasury securities. Assuming that banks use all funds except required reserves to make loans and that the public does not store any cash, the money supply should by about .
a. increase; $200 million.
b. increase; $1.67 billion.
c. decrease; $200 million.
d. decrease; $1.67 billion.

Option (b) is correct.

Explanation:

Given that,

Reserve requirement ratio = 12 percent

Treasury securities purchased by Fed = $200 million

Open market operations is a monetary policy tool used by the Fed for controlling the money supply in an economy. There is a buying and selling of government securities. If Fed buys the government securities then this will increase the money supply and if Fed sells the government securities then this will decrease the money supply.

Here,

Money supply increases by about:

= Treasury securities purchased by Fed ÷ Reserve requirement ratio

= $200 million ÷ 0.12

= $1,666.667 million

or 1.67 billion

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