Question

Which of the following would explain the shift in the money market shown above?

The required reserve ratio increasing
The central bank purchasing government bonds
A significant increase in business investment
A price level increase across the economy
An inflationary gap in the economy

Answer 1

The central bank purchasing government bonds would explain a shift in the money market, as it results in an increase in the money supply and the reduction of interest rates, consistent with expansionary monetary policy.

Step-by-step explanation:

The question seeks to determine which action would explain a shift in the money market. Specifically, the shift referred to usually implies a change in the money supply or interest rates. In the provided options, the action that would lead to an increase in the money supply is the central bank purchasing government bonds. Here's why:

• An increase in reserve requirements means banks must hold more funds as reserves, which would reduce the money supply because there would be less money available for banks to loan out.
• When the central bank purchases government bonds, it pays for these bonds with new money, directly increasing the amount of money in circulation in the banking system and thus increasing the overall money supply.
• An increase in business investment by itself would not shift the money supply; however, it might be a result of an increased money supply due to another action.
• A price level increase across the economy typically refers to inflation and does not directly signify a shift in the money supply. It might be a result of more money in the economy but doesn't cause the shift itself.
• An inflationary gap indicates that actual production is higher than potential production, which may result from excess money in the economy but does not directly cause a money supply shift.

In contrast to reserve requirements and other influences, buying bonds increases the money supply while selling bonds decreases it, as the central bank is injecting money into the economy when it purchases bonds from the banks.

Therefore, the correct answer is that the shift in the money market could be explained by the central bank purchasing government bonds, which would increase the money supply and typically lower interest rates. This aligns with the principles of expansionary monetary policy.