Question

Suppose the Federal Reserve purchases $1,000,000 worth of foreign assets.

a. if the Federal Reserve purchases the foreign assets with 51,000,000 in currency, show the effect of this open market operation, using T-accounts. What happens to the monetary base?
b. if the Federal Reserve purchases the foreign assets by selling 51,000,000 in T-bills, show the effect of this open market operation, using T-accounts. What happens to the monetary base?

Answer 1

A. Federal Reserve

Assets Liabilities

Foreign Assets $1,000,000 Currency in circulation $51,000,000

The federal liabilities increase by $51,000,000 in currency because it uses that money to purchase foreign assets which increase the foreign assets category by an equivalent amount. The monetary base is defined as the sum of currency circulating in the public and commercial banks reserve with the central bank

Since, the currency in circulation has increased. Thus, the monetary base will increase by $51,000,000

B. Federal Reserve

Assets Liabilities

Securities T-bill - $51,000,000

Foreign Assets $1,000,000

The federal is basically swapping T-bills with foreign assets. It did not use currency to make this purchase and the composition of assets changes, but the total does not.

Thus, the monetary base does not change