Question

Using the money supply (M1) model developed in class, explain the likely effects on the money supply of the following. Be sure your answer indicates what changes in the model.

a. the U.S. Treasury spends some of its account at the Fed

b. the Fed does an open market sale of bonds

c. banks lower the fees they had charged depositors each time a depositor uses a debit or credit card to buy goods or services

d. the Fed increases the interest rate it pays banks on reserves

e. banks borrow more from the Fed at the discount rate

Answer 1

a) It increases money supply as it shows increase in government spending.

b) Open market sale of bonds by the Fed decreases the money supply in the economy as Fed takes out money from the hands of public.

c) It causes increase in money supply as fall in fees induces customers to increase their number of transactions.

d) It causes decrease in money supply as increase in interest rate induces banks to reserve more. When bank increases their reserves then they lend less money in the economy and thus decreases money supply.

e) When banks borrow more from the Fed then they lend more money in the economy which increases money supply.