If the Treasury finances an expenditure by borrowing from the banking system, the money supply will not be affected if the banks
A) borrowed from the discount window to buy the government bonds.
B) had no excess reserves when they bought the bonds.
C) were not members of the Federal Reserve System.
D) had no other government securities in their portfolios.

Question

Quizplus · Accepted Answer

If the banks had no excess reserves when they bought the bonds, they would need to reduce their lending to maintain the required reserve ratios, which would offset the increase in reserves resulting from the Treasury's borrowing. Therefore, there would be no change in the money supply. The other options would have some effect on the money supply, either due to the banks' ability or inability to borrow, or the composition of their portfolio.

If the Treasury Finances an Expenditure by Borrowing from the Banking