Final answer:
The purchase of Treasury bonds by the Fed from a bank increases the bank's reserves and decreases its bond holdings, allowing the bank to issue new loans. In contrast, the sale of Treasury bonds to a bank decreases its reserves and increases its bond holdings, often leading to a reduction in the bank's loan portfolio to restore required reserves.
Step-by-step explanation:
When the Federal Reserve (Fed) conducts an open market purchase and buys Treasury bonds from a bank, such as Acme Bank, it impacts Acme Bank’s balance sheet by increasing its reserves and decreasing its holdings of bonds.
Conversely, when the Fed conducts an open market sale and sells Treasury bonds to a bank, this results in an increase in the bank's bond holdings and a corresponding decrease in its reserves.
Example of an Open Market Purchase
For instance, if the Fed buys $10 million in Treasury bonds from Acme Bank, the transaction would be reflected as follows:
Assets: The reserves would increase by $10 million due to the cash received from the sale of the bonds, while the bond holdings would decrease by $10 million.
Liabilities: There would be no immediate change in deposits or equity.
Acme Bank could then use the added reserves to extend new loans, affecting the balance sheet as follows:
Assets: The increase in loans by $10 million.
Liabilities: The deposits might increase if the loans result in new deposits, leaving equity unchanged.
Example of an Open Market Sale
Alternatively, if the Fed conducts an open market sale by selling $10 million in Treasury bonds to Acme Bank, the changes in the balance sheet would be:
Assets: The bond holdings increase by $10 million, while the reserves decrease by the same amount.
Liabilities: Again, no immediate change in deposits or equity.
If Acme Bank then needs to restore its required reserves, it might reduce loans which would decrease the assets side (loans) and potentially decrease liabilities (deposits), if combined with depositors withdrawing funds.