Question

the Federal Reserve wishes to decrease the money supply by $100 billion in order to reduce the possibility of high inflation in the years to come. Assuming a reserve requirement of 10 percent & that banks hold no excess reserves and the Fed wanted to use open market operations, would the Fed buy or sell bonds and how many bonds should the Fed buy or sell?

Answer 1

the Fed should sell $10 billion in securities

Step-by-step explanation:

intended goal is to decrease money supply by $100 billion

banks' required reserve ratio = 10%

money multiplier = 1 / reserve ratio = 1 / 10% = 10

the Fed should sell $10 billion in securities

total effect = -$10 billion x 10 (money multiplier) = -$100 billion

When the Fed sells securities, it is absorbing money, so it reduces the monetary base and money supply of the economy.