Question

How will the Fed's policy action change the money supply? Use only the actions corresponding to your choice jn the previous part

The money supply increases
1.The Red te The Fed sells bonds
2.The Fed sells foreign currency
3.The Fed increases the reserve ratio
4.The Fed decreases the rate at which it lends to mermber banks

The money supply decreases
1.The Fed buys bonds
2.The Fed buys foreign currency
3.The Fed decreases the reserve ratio oned
4.The Fed increases the rate at which ia lends to member banks

Answer 1

Federal Reserve actions like buying foreign currency can increase the money supply, while raising the discount rate can decrease it. These tools are used to influence credit availability and economic activity.

Step-by-step explanation:

The Fed's policy action can change the money supply in various ways, particularly through open-market operations and the discount rate. Open-market operations, which include buying and selling government securities, directly affect the money supply. For instance, when the Fed buys foreign currency, it increases the U.S. dollar supply in the foreign exchange market, potentially leading to a depreciation in the dollar's value, and an increase in the domestic money supply as the Fed pays for these currencies.

Moreover, when the Fed increases the rate at which it lends to member banks—the discount rate—this transaction can lead to a contraction in the money supply. A higher discount rate discourages banks from borrowing from the Fed, leading to a reduction in reserve balances and subsequently, banks have fewer funds available for lending, which can decrease the overall money supply.

In summary, monetary policy actions such as these are employed to either stimulate or cool down the economy by influencing the availability of credit and the level of economic activity.