If the government finances its spending by selling bonds to the central bank, the monetary base will ________ and the money supply will ________.

Question

BlackTom AI · Accepted Answer

1) Relevant knowledge points and concepts
- Monetary base (B) = currency in circulation + bank reserves held at the central bank. It is directly affected by central bank asset purchases/sales.
- Money supply (M) = money multiplier (m) × monetary base. The multiplier depends on the reserve ratio and currency-deposit preferences. When the central bank increases the base, the potential money supply expands unless the central bank sterilizes the operation.

2) Step-by-step reasoning
- The government “sells bonds to the central bank” means the central bank purchases government bonds (monetization of debt).
- The central bank pays for those bonds by crediting the Treasury’s account (and eventually commercial banks’ reserve accounts when the Treasury spends). That operation increases reserves in the banking system and/or currency in circulation — i.e., it increases the monetary base.
- With a larger monetary base and given positive money multiplier, the money supply increases as banks create deposits through lending.

3) Calculation example (intermediate steps)
- Suppose the central bank buys $100 of newly issued bonds. Monetary base ΔB = +$100.
- If the reserve ratio r = 0.1 and currency-deposit ratio k = 0 (for simplicity), the money multiplier m = 1/r = 10.
- Then potential change in money supply ΔM = m × ΔB = 10 × $100 = +$1,000. (This shows how an increase in the base magnifies into a larger increase in M.)

4) Why the correct answer is correct
- The central bank purchase injects reserves (increases B) and, through the multiplier process, raises the money supply (M). Therefore both the monetary base and money supply increase.

5) Why other options are incorrect
- b (not change; not change): incorrect because central bank purchases directly change the base.
- c (decrease; decrease): wrong direction — this operation expands, not contracts, central bank liabilities and reserves.
- d (increase; decrease): inconsistent — increasing the base will not reduce the money supply unless the central bank simultaneously sterilizes the operation (not stated).

6) Conclusion
- The correct choice is a. increase; increase, which matches the provided answer.

If the government finances its spending by selling bonds to the central bank, the monetary base will and the money supply will .Single choice

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If the government finances its spending by selling bonds to the central bank, the monetary base will ________ and the money supply will ________.Single choice