Assume that the reserve requirement is 20%. Also, assume that banks do not hold excess reserves and there is no cash held by the public. The Federal Reserve decides that it wants to expand the money supply by $40 million.

a. If the Fed is using open-market operations, will it buy or sell bonds?

b. What quantity of bonds does the Fed need to buy or sell to accomplish the goal? Explain your reasoning.

a. If the Fed is using open-market operations, will it buy or sell bonds? If the Fed wants to expand the money supply, it will buy bonds from its member banks, exchanging the bonds for cash which will be deposited into the banks.

b. What quantity of bonds does the Fed need to buy or sell to accomplish the goal? Explain your reasoning. To put $40 million into circulation with a reserve requirement of 20%, the Fed needs to put 120% of $40 million into the purchase of bonds. That would be $48 million - $8 million on reserve at the various banks, and $40 in circulation.