Suppose that the reserve requirement for checking deposits is 10 percent and that banks do not hold any excess reserves.

a. If the Fed sells $1 million of government bonds, what is the effect on the economy’s reserves and money supply?

b. Now suppose that the Fed lowers the reserve requirement to 5 percent but that banks choose to hold another 5 percent of deposits as excess reserves. Why might banks do so? What is the overall change in the money multiplier and the money supply as a result of these actions?