Question

Which of the following actions by the Federal Reserve would reduce the money supply? (You can only answer once)

an open-market purchase of government bonds

a reduction in banks’ reserve requirements

an increase in the interest rate paid on reserves

a decrease in the discount rate on Fed lending

Answer 1

In order to reduce the money supply, Fed generally administers the contractionary monetary policy.

Contractionary monetary policy includes -

1. An open-market sale of government bonds.

2. An increase in banks' reserve requirements.

3. An increase in the discount rate on Fed lending.

4. An an increase in the interest rate paid on reserves.

Thus,

The Federal Reserve would reduce the money supply by increasing the interest rate paid on reserves.

Hence, the correct answer is the option (3) [an increase in the interest rate paid on reserves].