Question

Briefly describe the effect on the money supply of the following monetary policies:

• The Fed purchases $20 million worth of U.S. Treasury bonds.
• The Fed increases the discount rate.
• The Fed decreases the discount rate.
• The Fed sells $40 million worth of U.S. T-bills.
• The Fed decreases the required reserve ratio.

Answer 1

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Effects on money supply of following monetary policies

A) The Fed purchases $20 million worth of U.S. Treasury bonds. Due to it, money supply will increase as it is expansionary monetary policy. For the purchase, fed will give liquidity.

B) The Fed increases the discount rate- It is an example of contractionary monetary policy. Due to it money supply will decrease. The reason is that due to increase in discount rate, borrowing cost of commercial banks will increase.

C) The Fed decreases the discount rate-It is an example of expansionary monetary policy. Due to it money supply will increase. The reason is that due to decrease in discount rate, borrowing cost of commercial banks will decrease.

D) The Fed sells $40 million worth of U.S. T-bills.- It is an example of contractionary monetary policy . Due to it money supply will decrease. The reason is that due to sale, fed will absorb money from the market and money supply will decrease.

E) The Fed decreases the required reserve ratio- It is expansionary monetary policy. Due to it money supply will increase . The reason is that due to less reserve requirement, commercial banks will have excess reserves and can create credit.