.5(20 points)Suppose that the T-account for First California Bank is as follows.

Assets

Liabilities

Reserves

$100,000

Deposits

$500,000

Securities

50,000

Loans

350,000

(1)Suppose that the Fed sells $20,000 securities to First California Bank. Draw the new T-account for First California Bank right after the Fed's sale.

Answer:

Assets

Liabilities

Reserves

$80,000

Deposits

$500,000

Securities

70,000

Loans

350,000

(2)Suppose that all banks, including First California Bank, continue to holds the exact amount of required reserves. As a result of the Fed's sale of $20,000 securities to First California Bank, how much of money supply will change?Is the change in money supply an increase or a decrease?

Answer:

First California receives $20,000 securities for the Fed, and the securities decreases the bank's reserves by $20,000.So, the amount of the bank's reserves will be $80,000.

The decrease of $20,000 in the bank's reserves amounts to an decrease in the monetary base in the economy, and results in the decrease in the money supply in the economy.

We know that the multiplier is (1/R) = 1/0.10 = 10.

So, the money supply will decrease by 20,000 10 = $200,000.

(Change in money supply = Change in Monetary Base Multiplier.)