If the central bank buys a government bond from an individual who then deposits the entire payment into their bank account, how will the money supply be affected?

Show Answers

Increase by a value determined by the bank’s reserve requirement ratioIncrease, but by less than the total deposited amountDecrease exactly by the amount deposited, provided the reserve ratio remains constantDecrease exactly by the amount deposited, as long as the reserve ratio is unchangedRemain the same without any change

Explanation

When the central bank purchases a government bond, it injects money into the economy. The individual deposits this money into a bank, which can then lend out a portion based on its reserve ratio. This process leads to an increase in the money supply by an amount influenced by the bank’s reserve requirement. Therefore, the money supply rises by an amount that depends on the reserve ratio.