When the Fed buys bonds from the public, reserves and the monetary base:

Question

BlackTom AI · Accepted Answer

Open-market purchase by the Fed increases bank reserves because the Fed pays for bonds by creating bank reserves, so both reserves and the monetary base rise.

1) Relevant concepts
- Open-market operations: Fed buys/sells government bonds to influence reserves and the monetary base.
- Reserves: bank deposits held at the Fed (plus vault cash) that count as part of the monetary base.
- Monetary base (high-powered money): currency in circulation + reserves held by banks at the Fed. An increase in reserves directly increases the monetary base.

2) Step-by-step reasoning with T-accounts
Start situation: public holds bonds; banks have current reserves R0; monetary base = currency + R0.

Fed buys $100 of bonds from a member of the public. Show changes with T-accounts (values in $):

Fed:
- Assets: Government securities +100
- Liabilities: Bank reserves +100

Seller’s commercial bank:
- Assets: Reserves +100
- Liabilities: Customer deposit +100

Seller (public):
- Assets: Deposit +100, Government securities −100

3) Intermediate calculation steps
- Fed creates +$100 in reserves: Reserves increase by $100.
- Monetary base change = Δreserves + Δcurrency. Here Δcurrency = 0 (payment was bank deposit), so Δmonetary base = +$100.

Numeric example:
Initial reserves R0 -> new reserves = R0 + 100
Monetary base initial MB0 = currency + R0 -> new MB = currency + (R0 + 100) = MB0 + 100

4) Why the correct answer is correct
Because the Fed’s purchase injects reserves directly into the banking system, reserves increase. Reserves are a component of the monetary base, so the monetary base increases by the same amount of newly created reserves.

5) Why other options are incorrect
- (a) decrease; decrease: wrong because the Fed is buying (injecting liquidity), not removing it.
- (b) increase; decrease: inconsistent — reserves can’t rise while the monetary base falls because reserves are part of the base.
- (d) decrease; increase: reserves would not decrease when the Fed injects funds.

6) Conclusion
Therefore reserves increase and the monetary base increases; the correct choice is c. increase; increase.

When the Fed buys bonds from the public, reserves and the monetary base:Single choice

Similar Questions

Contractionary monetary policy in an open economy with a floating exchange rate will likely ____ a trade surplus.

Which is contractionary monetary policy?

Which of the following tools affects the monetary base most directly?

The Fed can provide additional reserves to the banking system by either government bonds or discount loans.

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

Suppose the Bank of Japan buys U.S. dollar assets using yen; this causes:

If the federal funds rate is between the discount rate and interest on excess reserves, a decline in the reserve requirement:

If the federal funds rate is between the discount rate and interest on excess reserves, an increase in the reserve requirement:

More Practical Tools for Students Powered by AI Study Helper

Homework AI Solver

Stylized AI Paper Writer

Plagiarism Checker Assistant

Citation AI Academic Writing Tool

In-Class Translation Assistant

AI Note Generator

AI Quiz Answers

Past Exam Questions from University Test Bank

Smart Practice Assistant

Adaptive Practice

Making Your Study Simpler