Author Question: Suppose the Fed buys government securities from a commercial bank. Why is there a multiplier effect ... (Read 78 times)

rayancarla1 · **on:** Jun 29, 2018

Suppose the Fed buys government securities from a commercial bank. Why is there a multiplier effect on the quantity of money?

What will be an ideal response?

Question 2

The U.S. Gini ratio for income has ________ within recent decades, which means economic inequality has ________.

A) decreased; increased
B) decreased; decreased
C) increased; decreased
D) increased; increased

nmyers · **Reply #1 on:** Jun 29, 2018

Answer to Question 1

When the Fed buys government securities from a bank, the payment to the bank is in the form of reserves. Hence the bank gains excess reserves. The bank can loan these excess reserves. When the loan is spent, the recipients deposit some or all of the funds in their banks. These banks gain deposits (which increase the quantity of money) as well as excess reserves. The second round banks then loan their excess reserves. And when these loans are spent, once again the recipients deposit some or all of the funds in their banks. These third-round banks thereby gain deposits (which further increases the quantity of money) as well as excess reserves. These reserves are loaned, spent, and then deposited in a fourth round of banks, which still further increases the quantity of money. Hence the process of loaning and depositing the proceeds increases the quantity of money by a multiple of the initial amount of the open market operation.

Answer to Question 2

D