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SAVE MEEEE PLEASE! Help with Economics class!?
Suppose the economy is in a recessionary gap that needs $140bil worth of monetary stimulus to shift Aggregate Demand (AD) to its long-run “Full Employment” equilibrium output level. What kind of “Open Market Operation” of the Federal Reserve Bank would you use to close this $140 bil recessionary gap if the “Required Reserve” is 5%? (Be specific about the $ amount of your monetary stimulus).
1 Answer
- jerry wLv 71 decade agoFavorite Answer
When the Fed makes open market purchases it increases the money supply. It doesn't matter what it purchases, it could be bonds or candy bars.
An open market purchase would immediately increase the money supply by the amount of the purchase. It would also increase bank reserves by this amount. These reserves, to the extent that they are excess reserves, would also increase the money supply when banks make loans, etc. In this example, you have to assume that with a 5% reserve requirement, 95% of the open market purchase would be the amount of money created in the reserve system. This means that:
If x=amount of open market purchases, the amount needed would be:
x (the increase in money supply directly caused by the purchase) plus 0.95x (the amount of excess reserves created in the system) = monetary stimulus, or
1.95x = $140b
x = about $71.79b
Of course, in the long run there is a multiplier effect, but that information was not included in the question and generally an economic stimulus is designed for short term effects.
