Which of the following policy actions by a country’s central bank would decrease the money supply in the economy?a.Reducing the interest paid on bank reserves deposited with the central bank.b.Increasing the policy rate.c.Buying government bonds through open market operations.d.Decreasing the minimum reserve requirements.
Question
Which of the following policy actions by a country’s central bank would decrease the money supply in the economy?a.Reducing the interest paid on bank reserves deposited with the central bank.b.Increasing the policy rate.c.Buying government bonds through open market operations.d.Decreasing the minimum reserve requirements.
Solution
The policy action that would decrease the money supply in the economy is b. Increasing the policy rate.
When the central bank increases the policy rate, it makes borrowing more expensive. This discourages banks from borrowing, which reduces the amount of money they have to lend to consumers and businesses. As a result, the money supply in the economy decreases.
The other options would generally increase the money supply. Reducing the interest paid on bank reserves would encourage banks to lend more, increasing the money supply. Buying government bonds through open market operations injects money into the economy, increasing the money supply. Decreasing the minimum reserve requirements allows banks to lend more of their deposits, which also increases the money supply.
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