Question

To prevent banks from using excess reserves to make loans that would increase the money supply, the Federal Reserve could conduct open-market _____ and _____ the interest rate paid on bank reserves.

A) purchases; raise

B) purchases; lower

C) sales; raise

D) sales; lower

Pl elaborate in 150 words

Answer 1

To prevent banks from using excess reserves to make loans that would increase the money supply what Federal Reserve could do is that it would soak up the excess Reserves from the commercial banks.

When there will be less reserves available with the commercial banks automatically they will not be able to use exercises to make loan.

To reduce the reserves of the commercial banks the Federal Reserve could conduct open market sales of government securities. This will lead to to a decrease in the the bank Reserves and will lead to prevention of expansion of money supply by the banks through using excess reserves to make loans.

Moreover, Federal Reserve could also raise the interest paid on Bank Reserves. Effect of of increasing the interest rate on Bank reserves would be that the commercial banks would now be more willing to to keep their excess reserves with the Federal Reserve instead of making loans.

Hence, to prevent banks from using excess Reserves to make loans that would increase the money supply, the Federal Reserve could conduct open market Sales and raise the interest rate paid on Bank Reserves.

Therefore, option C is correct.