Question

Christopher buys a US Treasury security from the Federal Reserve in the secondary market. He pays cash. What is the result of this transaction?

1) The monetary base will increase, and the Federal Reserve will have a new asset.
2) Both the monetary base and bank reserves will increase.
3) The monetary base will decrease, and bank reserves will stay the same.
4) Both the monetary base and bank reserves will decrease.

Answer 1

The purchase of a US Treasury security from the Federal Reserve by an individual results in a decrease in the monetary base while bank reserves remain unaffected.

Step-by-step explanation:

When Christopher buys a US Treasury security from the Federal Reserve in the secondary market and pays cash, the correct result of this transaction is that the monetary base will decrease, and bank reserves will stay the same.

The reason for this is that when an individual (not a bank) buys a security from the Fed, money is transferred from the individual to the Fed, reducing the amount of cash in the hands of the public, hence decreasing the monetary base. As there’s no direct transaction with the banks’ reserves in this scenario, the bank reserves will not change.