Question

3. Open market operations versus discount loans

Consider an expansionary open market operation. Suppose the Federal Reserve buys government securities from the nonbank public.

Suppose that the sellers of government securities deposit the checks drawn on the New York Fed into their bank account. Then, ceteris paribus, bank reserves ___________ (increase / decrease / do not change) , currency in circulation ___________ (increase / decrease / do not change) , and thus the monetary base will ___________ (increase / decrease).

Suppose now that the Federal Reserve wants to increase the monetary base by increasing bank reserves only. Which of the following actions enables the Fed to achieve its goal?

A- Lend to commercial banks at the discount window

B- Buy the government securities exclusively from commercial banks

C- Buy the government securities exclusively from the non-banking public

D- Require commercial banks to repay discount loans

By lending to commercial banks through the discount window, the Federal Reserve alters ____________ ( currency in circulation / the discount rate / borrowed reserves / nonborrowed reserves / prices of government securities) and thus affects ____________ ( the monetary base / the discount rate / prices of government securities / banks’ willingness to borrow funds).

Answer 1

the sellers of government securities deposit the checks drawn on the New York Fed into their bank account. Then, ceteris paribus, bank reserves increase. ( because of the banks get new deposits)

currency in circulation increase. ( because banks can now lend more money as they have more deposits), and thus the monetary base will increase. (monetary base means the total amount of the currency in circulation)

Suppose now that the Federal Reserve wants to increase the monetary base by increasing bank reserves only. Which of the following actions enables the Fed to achieve its goal?

B- Buy the government securities exclusively from commercial banks

because now the deposits in the banks will increase directly.

By lending to commercial banks through the discount window, the Federal Reserve alters the discount rate and thus affects banks’ willingness to borrow funds.

because when the interest charged on the short term borrowings from the fed by the commercial banks goes down, the banks will be more willing to borrow funds from the fed.