Question

SA 1A- Central Bank Policy

Suppose the Federal Reserve decides to purchase $125 million in corporate bonds from First National Bank.

How do the balance sheets for the Fed and First National change after this purchase? What is the change in the monetary base?

Please with explanation

Answer 1

When the Federal Reserve will be buying the bond between that means, it is trying to increase the money supply into the economy so the overall cash balance of the Federal Reserve will be going down and the Assets of the Federal Reserve going to increase whereas in case of the commercial bank the assets are remaining similar due to cash increasing and value of bonds going down.

It is an exercise by federal reserve in order to stimulate the economy by increasing the money supply and it try to buy the bonds in order to provide the banks with the cash and liquidity and the bank will be providing this money to the public in order to increase the money flow so the cash on the books of banks will be increasing and loanable funds will also increase.

The changes in monetary base will be that the monetary base will be going to increase due to increase in cash and decreasing bonds