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### Your uncle repays a $\$\$100 loan from Tenth Natio…

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Problem 2

Explain whether each of the following events increases or decreases the money supply.

a. The Fed buys bonds in open-market operations.

b. The Fed reduces the reserve requirement.

c. The Fed increases the interest rate it pays on reserves.

d. Citibank repays a loan it had previously taken from the Fed.

e. After a rash of pick pocketing, people decide to hold less currency.

f. Fearful of bank runs, bankers decide to hold more excess reserves.

g. The FOMC increases its target for the federal funds rate.

The federal open market committee has increased its targets which have reduced the money
supply in an economy. It will be done by selling the government securities and holding more
money with them as compared to public.

## Discussion

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## Video Transcript

when the Fed buys bonds and open market operations, we need to think about what they're actually doing. When the Fed sens. Traders to the open market. These traders have to use United States currency to buy bonds on the open market when they use these federal dollars on the open market. That increases the money supply as money flows from the Federal Reserve to the money supply. Now, if the Fed reduces the reserve requirement this what does this actually mean? This means that banks have to hold on to a less currency, which means that banks can then lend out more money. When banks lend out more money, the money supply goes up and you can think about more money being in people's pockets. Now, if the fat increases the interest rate it pays on reserves, this is a little more nuanced. So when the Fed pays on the interest on this interest rate on reserves, the Fed is goingto pay banks more to hold on to more caps. So it's going to pay banks told onto more cash. So because the banks like this, they're going to hold on to that currency loan out less and so less money will be loaned out, which means that the money supply will be decreased. Next, it's City Bank repays alone that it previously taken from the Fed. What does this mean? Well, this means that banks, in this case, City, City, bank it's going to pay back It's loan to the Federal Reserve. Well, that money was once out here in the money supply. So it flows along here and so we can see that that will actually decrease the money supply. Okay, let's pretend that a rash of pickpocketing happens and people decide to hold on to a less currency. What is this actually going to do? Well, people are scared to hold on the cash. So what are people going to do? They're going to put their money in a bank If they're putting their money in the bank. That means that there's less cash in their hands, more in the bank. And that means that banks convention out, loan out more money for mortgages and things like that. What is that going to do to the money supply? Well, that's gonna increase the money supply. All right, imagine again. People here, they're fearful of bank runs they're going to try and pull all their money out of months. Okay, well, bankers are going to react to that, and they're going to hold onto Mohr excess reserves. They're gonna hold more money within the bank's walls. What's that going to do to the money supply? We'LL think about it, Banks, you're gonna lend out less money. And so there's going to be less money out there. So we're going to think that that's going to decrease the money supply. Lastly, if the Fed increases its target, open market operations increases its target for the federal funds rate. Remember the federal funds rate? That is the rate that banks loan one another when they are short on capture these very short term loans. So if the Fed is increasing its target, what does that mean? Well, if its target is to increase that rate so that it wants banks to have a higher interest rate that's loaning one another, that means that they are trying to decrease the money supply. That's the ultimate goal. But remember what the federal funds rate is. The Fed can't actually control this explicitly. They have to engage open market operations that will help bring this rate up, so they're going to take some of these actions if we've already talked about to try to raise the federal funds rate, all of which will decrease the money supply because as banks have to spend more money to loan each other short term cash, they're going to just hold on to that money, and that's going to decrease the money supply.