Which of the following policy actions by a country’s central bank would decrease the money supply in the economy?a.Selling government bonds through open market operations.b.Decreasing the minimum reserve requirements.c.Decreasing the policy rate.d.Reducing the interest paid on bank reserves deposited with the central bank.
Question
Which of the following policy actions by a country’s central bank would decrease the money supply in the economy?a.Selling government bonds through open market operations.b.Decreasing the minimum reserve requirements.c.Decreasing the policy rate.d.Reducing the interest paid on bank reserves deposited with the central bank.
Solution
The policy action by a country’s central bank that would decrease the money supply in the economy is a. Selling government bonds through open market operations.
Here's why:
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Selling Government Bonds Through Open Market Operations: When the central bank sells government bonds, it is essentially taking money out of the economy. The individuals or institutions buying the bonds pay the central bank, thus reducing the amount of money in circulation. This leads to a decrease in the money supply.
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Decreasing the Minimum Reserve Requirements: This action would actually increase the money supply. Lower reserve requirements mean banks need to hold less money in reserve, allowing them to lend more to consumers and businesses. This increases the money supply.
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Decreasing the Policy Rate: Lowering the policy rate, or the interest rate at which the central bank lends to commercial banks, encourages more borrowing. This would increase the money supply, not decrease it.
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Reducing the Interest Paid on Bank Reserves Deposited With the Central Bank: This would also likely increase the money supply. If banks are earning less interest on their reserves, they have more incentive to lend that money out, increasing the amount of money in circulation.
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