Hi I have got a doubt reg this MCQ appeared in UK exam paper in Sep 2007 The central bank conducts an open market sale of Treasury bills equivalent to $5 million. The commercial banks hold reserves equivalent to 5% of their deposits, while the public holds a cash to deposit ratio of 0%. What is the maximum that the Broad money supply may fall as a result of the open market operation? A. $125 million B. $100 million C. $25 million D. $6.25 million I got stuck with this. Please help me out.
If banks maintain a liquidity ratio of L = 5%, then the bank deposits' multiplier is equal to: b = 1/L = 20x So, a reduction in the banks' cash (liquid assets) of $5m will lead to a reduction in lending leading to a reduction in total deposits of: 20 x $5m = $100m. Note that the statement that "the public holds a cash to deposit ratio of 0%" means that all cash is held / redeposited in the banking system and so the bank deposits multiplier (b) and the money multiplier (m) have the same value. Note also that this question has been "tweaked" in the Revision Notes to reflect the current syllabus.
