Open market sales by the Fed:

Question

BlackTom AI · Accepted Answer

When the Fed conducts an open-market sale, it sells government securities to the public (or banks) and receives payment in bank reserves, so the Fed’s sale drains reserves from the banking system.

1) Relevant concepts
- Bank reserves = deposits banks hold at the Fed (plus vault cash).  
- Money supply (commonly M1/M2) expands when banks can lend out excess reserves; it contracts when reserves fall.  
- Money multiplier ≈ 1/required reserve ratio (rr). Open-market operations change reserves and thus affect the money supply through the multiplier.

2) Step-by-step reasoning
- The Fed sells securities worth X to a buyer. The buyer pays by using a bank deposit, which leads the bank to transfer X in reserves to the Fed.  
- Reserves in the banking system fall by X (the Fed’s holdings of reserves increase but those are removed from circulation).  
- With fewer reserves, banks have less capacity to make loans. Because loans create deposits, fewer loans mean fewer deposits and a smaller money supply.  
- The total change in the money supply equals the change in reserves times the money multiplier: ΔMoneySupply = ΔReserves × (1/rr). Since ΔReserves is negative (a decrease), ΔMoneySupply is negative.

3) Example calculation (illustrative)
- Suppose the Fed sells $100 million of securities and rr = 10% (0.10). Then money multiplier = 1/0.10 = 10.  
- ΔReserves = −$100 million, so ΔMoneySupply = −$100 million × 10 = −$1,000 million. The money supply falls by $1 billion.

4) Why the correct answer is correct
Open-market sales remove reserves and, via the deposit/loan multiplier, reduce the overall money supply.

5) Why other options are incorrect
- (a) claims reserves increase while money supply decreases — wrong because sales remove, not add, reserves.  
- (b) both increase — wrong; purchases (not sales) increase reserves and money.  
- (d) reserves decrease but money supply increases — contradictory to how deposit creation works.

Conclusion: Open market sales decrease reserves and decrease the money supply, so answer c is correct.

Open market sales by the Fed:Single choice

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