The central bank of Utopia conducts open-market purchases, buying government bonds from commercial banks. What are the impacts of this on the monetary base and money supply?
Question
The central bank of Utopia conducts open-market purchases, buying government bonds from commercial banks. What are the impacts of this on the monetary base and money supply?
Solution
When the central bank of Utopia conducts open-market purchases, it buys government bonds from commercial banks. This action increases the reserves of the commercial banks, which is part of the monetary base. So, the monetary base increases.
The increase in reserves allows commercial banks to lend more. As banks create money by lending, this leads to an increase in the money supply. So, the money supply also increases.
In summary, both the monetary base and the money supply increase when the central bank conducts open-market purchases.
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