3. 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 Fed 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.

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Required Reserve and Excess Reserve Analysis

A required reserve is an amount of cash that banks must keep with themselves, which is certain percentage of the deposits made by their customers. Required reserve is a percentage of the bank's deposits that the respective bank must have on each overnight. The percentage rate is set and determined by the nation’s central bank. It is important to have such funds accumulated to meet its uncertain obligations, sudden liabilities and withdrawals. Required reserve is also known as reserve ratio. Reserve ratio is an important tool to control the money supply.