Question

When the Federal Reserve System sells the U.S. Treasury securities to banks, this will ______ liquidity and thus, will result in ______ interest rates?

Answer 1

The Federal Reserve's sale of U.S. Treasury securities to banks decreases liquidity and generally results in increased interest rates as part of a contractionary monetary policy, affecting economic growth and demand for the dollar.

Step-by-step explanation:

When the Federal Reserve System sells U.S. Treasury securities to banks, this action decreases liquidity in the banking system because it involves banks exchanging their cash reserves for securities, which reduces the money supply available for lending. Consequently, this typically leads to increased interest rates, as banks have less money to lend, and the cost of borrowing goes up. In more than 100 words, this is part of a contractionary monetary policy where selling bonds increases the interest rates and reduces investment. With a higher interest rate, demand for the dollar also rises, causing an appreciation of the exchange rate. Both of these outcomes can lead to a slowdown in economic growth by reducing exports and aggregate demand.