Final answer:
The Federal Reserve directly alters the money supply during open market operations, which subsequently influences interest rates, particularly the federal funds rate, thus affecting the broader economy.
Step-by-step explanation:
The money supply:
The Federal Reserve directly changes the money supply during open market operations (OMOs). When the central bank engages in OMOs, it buys or sells U.S. Treasury bonds with the intent to adjust the amount of bank reserves. As a result, this influences the level of interest rates, particularly the federal funds rate, which in turn affects the broader economy.
The process works as follows: when the Federal Reserve buys securities, it increases the reserves of the banking system, leading to a higher supply of money. Conversely, selling securities results in a decrease in bank reserves and a contraction in the money supply. This manipulation of the money supply is intended to maintain the federal funds rate around the target set by the Federal Open Market Committee (FOMC), influencing overall economic activit.