How do open market operations affect the monetary base?

How do open market operations affect the monetary base?

• A. They primarily shift fiscal policy.
• B. They change the monetary base and money supply by buying or selling Treasuries.
• C. They adjust reserve requirements directly.
• D. They determine the discount rate.

Answer: (B)

Open market operations change liquidity in the banking system by the central bank buying or selling government securities. The monetary base is the sum of currency in circulation plus bank reserves. When the central bank buys Treasuries, it pays by crediting the seller’s bank reserves at the central bank, increasing reserves and expanding the monetary base. That higher base supports more lending and deposits, which in turn raises the money supply through the money multiplier. Conversely, selling Treasuries withdraws reserves, shrinking the base and pulling the money supply down. So, open market operations affect the monetary base directly by altering reserves (and hence currency context), with the money supply changing indirectly as banks create additional deposits from those reserves. Other tools—like reserve requirements or the discount rate—are separate policy instruments and do not describe the same mechanism of changing the base through security transactions.

Open market operations change liquidity in the banking system by the central bank buying or selling government securities. The monetary base is the sum of currency in circulation plus bank reserves. When the central bank buys Treasuries, it pays by crediting the seller’s bank reserves at the central bank, increasing reserves and expanding the monetary base. That higher base supports more lending and deposits, which in turn raises the money supply through the money multiplier. Conversely, selling Treasuries withdraws reserves, shrinking the base and pulling the money supply down. So, open market operations affect the monetary base directly by altering reserves (and hence currency context), with the money supply changing indirectly as banks create additional deposits from those reserves. Other tools—like reserve requirements or the discount rate—are separate policy instruments and do not describe the same mechanism of changing the base through security transactions.