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QUESTION 4 If the Federal Reserve increases the amount of reserves (or 'fed funds') in the banking sector, how much will money in the economy

QUESTION 4

  1. If the Federal Reserve increases the amount of reserves (or 'fed funds') in the banking sector, how much will money in the economy change?

Since only the Federal Reserve can create money, the increase in reserves is by definition EXACTLY EQUAL to the increase in money.

The money supply will decrease since the Federal Reserve buys bonds to increase reserves.

Because banks need to keep a fraction of deposits in reserves, the increase in money will BE LESS than the increase in reserves.

Because of the deposit multiplier process the increase in money will usually be MUCH LARGER than the increase in reserves.

1 points

QUESTION 5

  1. If the Federal Reserve increases the interest rate it pays on reserves, how will this affect banks?

The rise in interest on reserves will increase the deposit multiplier.

Banks will have less incentive to make loans since they can instead earn higher risk-free interest payments from the Federal Reserve.

Banks will have more incentives to get rid of reserves since they are now charged more for holding them.

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