Question

1. Explain how each of the following situations changes the quantity of money (money supply) in the economy, based on its computed change in the money supply.

a) The Federal Reserve System buys bonds

b) The Federal Reserve System auctions credit

c) The Federal Reserve System raises the discount rate

d) The Federal Reserve System raises the reserve requirement

Answer 1

a) Fed buying bonds in the market will increase the money supply as they will be giving money in return of the bonds, this will also lower the interest rate.

b) Auctioning credit will again increase the money supply in the market due to extra lending in the market,

c) Raising the discount rate will make borrowing costlier and investment will fall, this will reducing loaning activity and that will lead to a fall in the money supply.

d) Raising the reserve requirement will leave less cash with the banks in the market to lend, this will reduce the lending in the market and that will reduce the money supply.