Final answer:
The Federal Reserve frequently uses open market operations to adjust the money supply by influencing the federal funds rate through the buying and selling of U.S. Treasury bonds.
Step-by-step explanation:
The method used most often by the Federal Reserve to change the money supply is through open market operations, with the goal to influence the federal funds rate, which is an interest rate. Open market operations involve the buying or selling of U.S. Treasury bonds to adjust the quantity of bank reserves, thereby affecting the level of interest rates. The federal funds rate, despite its name, is the interest rate at which commercial banks lend to each other on an overnight basis.
The Federal Reserve's decisions to buy or sell these Treasury bonds can either increase or decrease the money supply. When the Fed buys treasury bonds, it increases the reserves of the banks, thus lowering the federal funds rate and encouraging more lending and borrowing. Conversely, when the Fed sells bonds, it takes money out of circulation, decreasing the reserves, raising the federal funds rate, and generally leading to less borrowing.