Part 1If the Treasury has just paid a large bill to defense contractors and as a result its deposits with the Fed fall, what defensive open market operations will the manager of the open market desk undertake? Part 2
A. A defensive open market sale. B. A repurchase agreement. C. A defensive open market purchase. D. None of the above are correct.

Question

Part 1If the Treasury has just paid a large bill to defense contractors and as a result its deposits with the Fed​ fall, what defensive open market operations will the manager of the open market desk​ undertake? Part 2
A. A defensive open market sale. B. A repurchase agreement. C. A defensive open market purchase. D. None of the above are correct.

BlackTom AI · Accepted Answer

When the Treasury makes a large payment to defense contractors, the banking system experiences a drain in deposits held at the Fed, reducing reserves. 
Option A: A defensive open market sale would have the opposite effect by selling securities and pulling more reserves out of the system, worsening the drain rather than offsetting it.
Option B: A repurchase agreement (repo) is a short-term financing operation that, depending on the orientation, can temporarily alter liquidity, but it is not the standard defensive move to offset a reserve drain caused by a fiscal payment; moreover, the typical defensive action to immediately replenish reserves is not described as a repo in this context.
Option C: A defensive open market purchase directly increases reserves in the banking system by the Fed buying securities, which offsets the reserve drain caused by the Treasury payment and aligns with the goal of stabilizing the system’s liquidity.
Option D: None of the above are correct would only be true if none of the listed actions addressed the reserve drain, but a defensive open market purchase (Option C) does precisely that by injecting reserves.
In summary, the intended response to a reserve drain from a large fiscal outlay is to add liquidity via an outright purchase (defensive open market purchase), not to drain liquidity or rely on a repo that may have different liquidity implications.

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