Final answer:
To decrease the money supply, the Federal Reserve should sell U.S. bonds. This action reduces banks' reserve balances and decreases their capacity to lend, leading to a contraction in the money supply. Raising the discount rate or required reserve ratio would also decrease the money supply, but these options are not listed in the student's choices.
Step-by-step explanation:
If the Federal Reserve wants to decrease the money supply, it should sell U.S. bonds. By selling bonds, the Fed reduces the reserve balances of banks because the banks pay for the bonds with their reserves. This process causes a reduction in the money supply because, as banks have fewer reserves, they lend out less money to the public. Additionally, selling bonds tends to increase interest rates, which can further reduce the money supply by making borrowing more expensive and thus less attractive.
Raising the required reserve ratio would also decrease the money supply by requiring banks to hold more reserves against their deposits, reducing the amount they can lend out. However, this option is not listed among the student's options. Likewise, increasing the discount rate can also decrease the money supply by making it more costly for banks to borrow reserves from the Fed, leading them to reduce lending.
In contrast, buying U.S. bonds, decreasing taxes, and lowering the discount rate are policies that would increase the money supply, not decrease it. Therefore, the correct answer is that the Federal Reserve should sell U.S. bonds to decrease the money supply.