Multiple Choice
To stimulate the economy, the Federal Reserve can:
18. The Monetary System
The Federal Reserve and the Money Supply
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If the Federal Reserve conducts open-market sales, what happens to the money supply?
A
It decreases.
B
It remains unchanged.
C
It increases.
D
It fluctuates unpredictably.
Verified step by step guidance1
Understand that open-market operations are actions by the Federal Reserve to buy or sell government securities in the open market to influence the money supply.
Recognize that an open-market sale means the Federal Reserve is selling government bonds to the public or banks.
When the Fed sells bonds, buyers pay for these bonds by using their bank reserves or cash, which reduces the amount of reserves banks hold.
With fewer reserves, banks have less capacity to create loans, which leads to a decrease in the overall money supply through the money multiplier effect.
Therefore, the money supply decreases as a result of the Federal Reserve conducting open-market sales.
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