Question

1.Describe the effect of each action below will have on the money supply. Explain your reasoning

A. The fed raises the discount rate from 5% to 10%

B. The required reserve ratio is lowered from 20% to 10%

C. The fed sells $5 billion worth of T-bonds on the open market

D. The fed buys $5 billion worth of T-bonds on the open market

E. Banks decide to keep more of their assets as reserves in order to avoid risking a shortage of the required reserve

Answer 1

A: When the Fed raise the discount rate, it is more expensive for banks to borrow from the Fed. So, the banks will have less reserves to loan because it is more expensive. This will lead to a decrease in the money supply.
B: When the Fed decreases the required reserve ratio, banks are allowed to loan more money. This will increase the money supply.
C: Whenever the bank sells T-bonds it decreases the amount of money in an economy, which lowers the money supply.
D: Whenever the Fed buys T-bonds it increases the amount of money in an economy, which increases the money supply.
E: The banks are increasing the amount of reserves they have. When the amount of reserves are increased the bank has more money to loan. This leads to the money supply increasing.

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