A central bank purchase of foreign assets and sale of domestic currency causes:

Question

BlackTom AI · Accepted Answer

When a central bank buys foreign assets it acquires foreign currency (increasing international reserves) and pays for them by supplying domestic currency, which raises the monetary base.

1) Relevant knowledge points and concepts
- Central bank balance sheet: Assets include foreign assets (international reserves); liabilities include the monetary base (currency in circulation + reserves held by banks at the central bank).
- Open-market operations: Purchasing assets increases central bank assets; paying with newly issued domestic currency increases its liabilities (monetary base).
- “Sale of domestic currency” here means the central bank supplies/creates domestic currency to complete the purchase.

2) Step-by-step reasoning (accounting view)
- Initial action: Central bank purchases foreign assets (e.g., foreign bonds).
- Accounting entry on central bank balance sheet:
  - Assets: +Foreign assets (international reserves) 
  - Liabilities: +Monetary base (currency in circulation or bank reserves)
- Therefore both the asset side (international reserves) and liability side (monetary base) increase by the purchase amount.

3) Intermediate steps shown explicitly
- Before: Assets = A, Liabilities (Monetary base) = L.
- Operation: Buy foreign assets worth X.
- After: Assets = A + X (because foreign assets ↑ by X), Liabilities = L + X (because monetary base ↑ by X).
- Net effect: International reserves ↑ X; Monetary base ↑ X.

4) Why the correct answer is correct
- The central bank acquires foreign assets, increasing international reserves. It pays by issuing domestic currency, increasing the monetary base. That exactly matches “an increase in international reserves and the monetary base.”

5) Why the other options are incorrect
- (a) Decrease in reserves and increase in monetary base: wrong because reserves increase (not decrease) when foreign assets are purchased.
- (b) Decrease in reserves and monetary base: both signs wrong; purchase raises reserves and raises the monetary base.
- (d) Increase in reserves and decrease in monetary base: incorrect because issuing/selling domestic currency to pay increases (not decreases) the monetary base.

6) Conclusion
This analysis confirms the correct choice is c. an increase in international reserves and the monetary base.

A central bank purchase of foreign assets and sale of domestic currency causes:Single choice

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