Question

Suppose the central bank conducts an unusually large open market purchase of bonds held by the First National Bank of $1400 billion due to a sharp contraction in the economy. Before the First National Bank turns proceeds to productive uses, update the balance sheet of the First National Bank

Answer 1

When the central bank conducts an open market purchase of bonds then it stimulates the economy to decrease unemployment by increasing the money supply in the economy through purchases of bonds in the open market .Now to understand how the central government purchases bonds from the commercial bank and what effect it will have on the balance sheet of commercial bank , we first need to assume a certain balance sheet of commercial bank as given below:-

Balance Sheet of First National Bank

Assets	Amount	Liabilities	Amount
Reserves	600	Deposits	3100
Securities	2000
Loans	500
Total	3100	Total	3100

Now when the central bank purchases bonds from the commercial banks through open market operations it reduces the amount of securities available with the commercial bank by 1400 billion and increases the reserves held with the commercial bank buy 1400 billion which can be depicted in the following balance sheet.

New Balance Sheet of First National Bank

Assets	Amount	Liabilities	Amount
Reseves	2000	Deposits	3100
Securities	600
Loans	500
Total	3100	Total	3100

Thus purchases of securities from the commercial bank leads to increment in the amount of reserves held with the commercial bank. Thus a commercial bank will choose to reduce its reserves by giving loans in order to on interest income which will automatically increase the money supply in the economy.