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Monetary policy change and its effect on nominal interest rate (in the short run): Suppose that...

Monetary policy change and its effect on nominal interest rate (in the short run):

Suppose that the Fed decreases the money supply. Use the money market diagram to show how the interest rate reacts to the Fed’s monetary policy change in the short run. Then, briefly explain how the Fed should conduct open market operation in order to decrease money supply. (Is it an open market sale or purchase of government bonds?)

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When the fed decrease the money supply, the money supply curve shifts to the left indicating decrease in money supply and cause to increase the interest rate ,because when money supply decrease, the bank and financial insitutions have left with less money to lend , therefore the interest rate will increase .

The Fed should conduct ope market operation by sale of government bonds to decrease the money supply . hence the fed shoud sell government bonds in the open market .

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