Question

An open market sale of government securities by the Federal Reserve will

a. decrease bank reserves, decrease bank loans, decrease the money supply and decrease interest rates
b. increase bank reserves, increase bank loans, increase the money supply and increase interest rates
c. decrease bank reserves, decrease bank loans and decrease the money supply while raising interest rates
d. increase bank reserves, increase bank loans, increase the money supply while decreasing interest rates

Answer 1

C) Decrease bank reserves, decrease bank loans and decrease the money supply while raising interest rates

Step-by-step explanation:

Selling by the Federal reserve of government securities is an application of contractionary monetary policy. These securities are purchased by the commercial banks which results in a reduced reserve for these banks. This reduction in reserve restricts credit creation which is the banks, ability to lend loans. When there are less loans in the market - there is a reduced money supply in the market and thus the cost of borrowing or interest rates are pushed higher because of limited money supply.

Similarly purchasing these securities will leave banks with ample money and more credit can be created thus inducing the opposite effect.

Hope that helps.