Suppose the Fed decides it needs to pursue an expansionary policy. Assume people hold no cash, the reserve requirement is 20%, and there are no excess reserves.
a. Show how the Fed would increase the money supply by $2M through changing the reserve requirement.
b. Show how the Fed would increase the money supply by $2M through open market operations© BrainMass Inc. brainmass.com March 4, 2021, 6:48 pm ad1c9bdddf
a. The simple formula that relates the monetary base (which is what is affected by open market operations) and the reserve requirements to the money supply is the following:
Money Supply = (1/RR)*(Monetary Base)
where RR are the reserve requirements (in this case, RR=0.2) and (1/RR) is the "money multiplier". Let's call M to the money supply and B to the monetary base.
M = (1/RR)*B
We want to take the money supply to M + 2 (you didn't supply a value for M in your question). Now, M + 2 can be rewritten as:
Contextualize expansionary policy.