Question 1 (10 marks):

Supposed commercial banks in Canada are required to maintain a reserve requirement equal to 20% of deposits. Also, assume that these banks do not hold any excess reserves.

a. If the Bank of Canada sells $2 million of government bonds, what is the effect on Canada's reserves and money supply? (4 marks)

b. Now suppose the Bank of Canada lowers the reserve requirement to 5%, but the commercial banks choose to hold another 5% of deposits as an excess reserve. Why might banks do so? (2 marks)

What is the overall change in the money multiplier and the money supply as a result of these actions? (4 marks)