Answer
a) Reserves decrease by 1 million dollars, and the money supply decreases by 10 million dollars.
b) Increased reserves might be held for day-to-day operations. There is no change to the money supply.
Work Step by Step
a)
If the Fed sells 1 million of government bonds, then the banks will buy those bonds. Purchasing the bonds will decrease the reserves of the banks by 1 million dollars. Since the required reserve ratio is 10%, we see that the money multiplier is $1/.1$, or 10. The decrease in the reserves of 1 million dollars, multiplied by the money multiplier of 10, results in a decrease to the money supply of 10 million dollars.
b) These day-to-day operations could include paying other banks for the transactions of customers and making change. Since banks would hold excess reserves so that there is no change to the total reserve ratio, there would be no change to the money multiplier. Thus, there is no change to the money supply.
