Federal Reserve policy requires Sun-Trust Bank to hold 12% of its deposits as reserves. Sun-Trust Bank policy prevents it from holding excess reserves. If the Federal Reserve Bank purchases $20 million in bonds from Sun-Trust what will be the result? a. Sun-Trust's loan assets decreases by $20 million b. Sun-Trust's liability decreases by $20 million c. Sun-Trust's loan assets increases by $20 million the money supply in the economy increases

When the Federal Reserve (often referred to as the Fed) purchases $20 million in bonds from Sun-Trust Bank, the bank's reserves will increase by $20 million. This transaction adds money to Sun-Trust's reserves because the Fed pays for the bonds by crediting Sun-Trust Bank's reserve account with the Federal Reserve.

Given the bank's policy of not holding excess reserves, it will seek to loan out the new excess. Since the required reserve ratio is 12%, Sun-Trust is required to hold $2.4 million ($20 million * 12%) of the new money as reserves and can loan out the remaining $17.6 million (i.e., $20 million - $2.4 million). These new loans will increase the bank's loan assets by up to $17.6 million, not the full $20 million because it must retain 12% in reserves.

Regarding the choices provided: a. Sun-Trust's loan assets do not decrease by $20 million. They are set to potentially increase since the bank has more reserve to issue loans. b. Sun-Trust's liability does not decrease by $20 million. Instead, the bank's reserves within the Federal Reserve increase by $20 million. c. Sun-Trust's loan assets increases by up to $17.6 million, which is the correct portion of the money that can be loaned out considering the reserve requirement.

As the bank loans out this money, the money supply in the economy is likely to increase, due to the money multiplier effect, where each dollar of reserve in the banking system can create several dollars of new loans and thereby increase the aggregate money supply.

Extra: The Federal Reserve System is the central bank of the United States and is responsible for conducting the nation’s monetary policy by influencing money and credit conditions in the economy in pursuit of full employment and stable prices. One of the tools the Fed uses to conduct monetary policy is open market operations, which involve the buying and selling of government securities, such as bonds.

When the Fed buys securities, as it did in this scenario, it increases the reserves of the banking system. This process is also known as "injecting" money into the economy, and it is typically done to lower interest rates and stimulate economic activity by making more funds available for banks to loan out.

The money multiplier is a factor that determines how much the money supply can increase after an initial cash deposit into the banking system. For example, if the reserve requirement is 12%, the money multiplier would be approximately 8.33 (1 divided by 0.12), meaning that every dollar of reserves can theoretically support up to $8.33 of new money in the economy through the lending process. It's important to understand that banks create money by making loans. As banks lend more, the recipients of those loans put the money back into the banking system, where it becomes the basis for more loans, and the cycle continues. However, the actual increase in the money supply also depends on other factors, such as how much new loans are sought by borrowers and how quickly money circulates among users.