Suppose that the Treasury decides to spend $12 billion on a given day. Because about $12 billion in new tax revenues are expected to replenish the Treasury's account at the Fed a week later, the best policy for the Fed to pursue if it wishes to stabilize reserves is to
A) do a $12 billion government security repurchase agreement.
B) do a $12 billion government security reverse repurchase agreement.
C) buy $12 billion in government securities outright and hold them to prevent bank reserves from falling.
D) sell $12 billion in government securities to prevent bank reserves from rising.

Question

Quizplus · Accepted Answer

The best policy for the Fed to pursue in this situation would be to conduct a $12 billion government security reverse repurchase agreement. This would involve the Fed selling $12 billion in government securities to banks, with the agreement to buy them back at a slightly higher price in a week's time when the tax revenues replenish the Treasury's account. This way, the Fed can temporarily remove excess reserves from the banking system and prevent interest rates from falling too low, while also ensuring that reserves will be replenished in a week's time. Other options, such as outright purchases or sales of government securities, could lead to unintended consequences in the market if not timed or executed correctly.

Suppose That the Treasury Decides to Spend $12 Billion on a Given