Suppose that the reserve requirement ratio is 4% and that the Fed uses open market operations (OMO) by BUYING $200 million worth of Treasury securities. Assume that banks use all funds except required reserves to make loans and that the public does not store any cash.
A. Does this Fed action increase or decrease the money supply (all else equal)? EXPLAIN
B. Given the information above, what is the best estimate of how much the money supply changes as a result of the Fed’s action?SHOW YOUR WORK.
C. Describe another tool at the Fed’s disposal to change the money supply in the same direction: tell what it is called, how it works, and how it would serve to change the money supply in the same direction as the OMO above. Why is it more likely that the Fed will use OMO instead?