Question

2. What is an open market sale? Suppose the Fed conducts an open market sale of $5 million How does that affect the monetary base? Explain using the T-accounts for the Fed and the Banking System.

Answer 1

Fed can control the money supply with the open operations, Fed sells and buys the government securities in the open market. The open market sale occurs when Fed sells the government securities and reduces the money supply.

For example: Fed conducts an open market sale and sells the $5 million worth of securities to Bank-ABC. Fed surrenders the securities to Bank-ABC, and as a result it reduces the balance in Bank-ABC by $5 million. After the open market sale worth $5 million the T-accounts for the Fed and Bank-ABC would appear as follows:

FED
Assets	Liabilities
Government securities -$5 million	Reserves on deposit at the Fed -$5 million
Bank-ABC
Assets	Liabilities
Government securities +$5 million	No change
Reserves on deposit at the Fed -$5 million