Question

The Fed sells a U.S. government security and a bank dealer writes a check for the amount. When the check clears

a. reserves have fallen by the amount of the check because the Fed clears the check by reducing the bank's deposits at the Fed.

b. reserves have fallen by the amount of the reserves times the reserve ratio, and the money supply falls by the difference between the amount of the check and the fall in the reserves.

c. reserves remain unchanged because the decrease of reserves at the dealer's bank is offset by an increase in the reserves at the Fed.

d. reserves increase by the amount of the check because the Fed clears the check by increasing the amount of the bank's deposits with the Fed.

Answer 1

Reserves has fallen by the amount of the check because the Fed clears the check by reducing bank deposits at the Fed

When Fed wants to decrease money supply in the economy it sells government securities to commercial bank. Selling of government securities by Fed reduces the reserves of the commercial bank as Fed sells bonds in exchange of cash or check with commercial bank. So when check clears the reserve of commercial bank reduce by the amount of check. As a result deposit of banks reduces at the Fed.