Question

Explain how each of the following changes quantity of money (money supply) in the economy.

a. the Fed buys bonds
b. the Fed auctions credit
c. the Fed raises the discount rate
d. the Fed raises the reserve requirement

Answer 1

a. the Fed buys bonds ⇒ increases the money supply because it buys bonds and pays in cash

b. the Fed auctions credit ⇒ decreases the money supply because it sells bonds and receives cash

c. the Fed raises the discount rate ⇒ decreases the money supply because an increase in the discount rate will affect interest rates in all the economy. Higher interest rates decrease the amount of money that households want to hold and increases household spending.

d. the Fed raises the reserve requirement ⇒ decreases the money supply since banks have less money to lend and interest rates will increase.