Question

An open market sale of US Treasury bonds by the central bank will ________ credit conditions for private firms.

A. ease

B. restrict

C. not change

Answer 1

Open market operations are conducted by the Federal Reserve as a response to increasing inflation in the country. The main aim of this is to restrict the flow of money in the economy. When the Federal Reserve sells bonds in the open market, the net result of the same is that those that purchase these bonds, part away with money and receive bonds in return. The flow of money in the economy thus shrinks. It is important to note, that these bonds are usually bought by banks or others with a view to invest their money.

Now, that we know that an open market sale would reduce the flow of money in the economy, the credit availability would also shrink or be restricted as banks, when they purchase bonds in the open market do not have capital to then give away as loans.

For example, if the currency in circulation was 100$ and the banks bought bonds for 10$, then the remaining 90$ can only be given to private firms or individuals. As the capital which the banks hold decreases so does it restrict the credit conditions for private firms.

Thus, Option B can be concluded to be the correct answer in this case.

Please feel free to ask your doubts in the comments section if any.