Suppose the Fed buys $10,000 worth of bonds in an open market operation. It pays Seller 1 $10,000. To pay the seller, the Fed creates $10,000 in central bank money. Suppose that people hold 75% of their money in currency. Also, suppose that banks keep 10% of checkable deposits as reserves and lend the remaining 90%. Seller 1 deposits part of her money in a checking account in Bank A.

a How much money does Seller 1 deposits at Bank A?

b How much will Bank A lend from these new deposits?

c Describe an simple example such that some fraction of the loan in b) is deposited at another bank, Bank B, in the form of checkable deposits. Compute the value of those deposits. The chain of events and flows that we are after is: FED $10000 Seller 1 Deposits a Bank A Loan b Borrower 1 (Your example) Deposits c Bank

The example in c) must be consistent with our framework.