Question:
Suppose the statutory reserve requirement is 10% and the Central Bank conducts an open market purchases of Rs. 300 million from the commercial banks. What is the maximum possible change in the money supply resulting from this purchase?
(1) Increase of Rs. 300 million
(2) Decrease of Rs. 300 million
(3) Increase of Rs. 3 000 million
(4) Decrease of Rs. 3 000 million
(5) Decrease of Rs. 2 700 million
Correct Answer:
(3)
Answer Explanation:
When the Central Bank purchases securities, it injects new base money (300 million) into the banking system. The money multiplier is $1 / text{Reserve Ratio} = 1 / 0.10 = 10$. The maximum increase in the total money supply is the injection multiplied by the multiplier: $300 times 10 = 3000$ million increase.
Topic: Monetary Policy Year: 2020
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