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If the government conducts an open-market purchase, this will
If the government conducts an open-market purchase, this will...
a.
Cause interest rates to increase.
b.
Increase the monetary base.
c.
Decrease the money supply.
d.
Cause reserve ratios to decrease.
Expert Solution
- Open market purchase is a quantitative method used by government to control inflation or money supply in the country .
- Open market purchase refer to sale and purchase of govenment securities and treasury bills by the central bank to control regulate money supply in the economy
- When the central bank wants to increase the money supply , it purchases the government securities, , bills, and bonds. from people
- As a result ,money supply in the economy will increase
- Option A is not correct ,when the money supply in the market increases it will cause the interest rate to decrease not increase.Low interest rate will increase investment in the economy
- Option b-Increase in monetary base is correct
monetary base in a country is the total amount of bank notes and coins, total currency held by the public,plus the currency held in the vaults of commercial banks, and commercial banks' reserves held in the central bank. if they purchase government bonds from commercial banks, central bank pay for these banks by adding new amounts to the banks’ reserve deposits at the central
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.Central bank purchases bonds from commercial banks, the central bank takes the illiquid bonds and replace it with a cash deposit in the bank’s reserve .
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So commercial banks' reserves held in the central bank is a component of monetary base .So eventually the monetary base will increase.
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Option c-Decrease in money supply is not correct.When central bank purchase government securities or bonds it will increase money supply not decrease the money supply.When government purchases securities from public .It will increase cash holdings of a person .
-
Option D- Cause reserve ratios to decrease is not correct .The central bank wants to increase money supply .It is using one method that is it is increasing open market purchases.Reducing reserve ratio is another method to control money supply in the economy .The central bank will not use two methods together to control money supply in the economy.Currently they are using open market operations or purchases .Maybe in other situation ,they will use this method to control money supply in market
- The reserve ratio, set by the central bank, it is the percentage of a commercial bank's deposits that it keep in cash as a reserve in case of mass customer withdrawals.The central bank lowers the reserve ratio to give banks more money to lend and boost the economy and increases the reserve ratio when it wants s to reduce the money supply and control inflation in the economy .When they increase reserve ratio they have to keep more cash as reserve and they have to reduce giving loans to public.
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