Final answer:
The quantity of money will not change if people hold more currency outside banks, as this is still part of the money supply. When Happy Bank purchases bonds, it adjusts loans to maintain a desired reserve level. An increase in loan supply leads to an increase in loans made and received.
Step-by-step explanation:
When there is an increase in the amount of currency held outside banks, the quantity of money in terms of the overall money supply does not change. The portion of currency that people are holding is still part of the money supply, even if it is not within the banks. Therefore, the correct answer to the student's question is (a) quantity of money will not change.
When banks hold more reserves due to open market operations, such as purchasing bonds from the central bank, they will adjust their quantity of loans to maintain a desired reserve level. If a bank wants to increase its reserves, it can slow down or stop issuing new loans, which then decreases the quantity of loans in the economy. Consequently, when Happy Bank purchases the bonds and thereby depletes its reserves, it will reduce its loan issuance to replenish its reserves back to the desired amount. This adjustment doesn't change the monetary base – only the distribution between reserves and bonds changes.
To answer the subsequent question unrelated to the main discussion, an increase in the quantity of loans made and received could be caused by a rise in supply of loans, but not by a fall in demand. Increased demand would usually lead to more loans only if the supply of loans is also able to increase.