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In: Economics

The monetary base will _____________ and money supply will __________ when the Fed sells bonds via...

  1. The monetary base will _____________ and money supply will __________ when the Fed sells bonds via an open market operation.

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Expert Solution

The monetary base will increase and money supply will decrease when the Fed sells bonds in an open market operation.

Monetary base is sum of currency in circulation and commercial bank reserves that is held by Fed in its reserve. When Fed sells bonds via an open market operation, commercial banks purchase them at repo rate and this lead to increase in reserves held by Fed.

On the other hand, Money supply is sum of currency in circulation and demand depositsat banks. Now, banks have less reserve to loan out to public due to purchasing of bonds from Fed. As presence of lesser reserves with banks, they are not able to loan out every possible amount to public. This operation by Fed lead to decreasing in Money supply and control the inflation and execution of monetary policy.

One should not get confused between monetary base and money supply as there is slight difference between bioth. One talks about reserves held by central bank and other reserves held by commercial banks in form of demand deposits. Monetary base is created by centyral bank for the economy and money supply is actual currency in economy.

Rahul Sunny answered 6 months ago
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