When the Bank of Canada buys government bonds, how do the reserves of the banking system change and what happens to the money supply?
A) The reserves increase, so the money supply increases.
B) The reserves increase, so the money supply decreases.
C) The reserves decrease, so the money supply increases.
D) The reserves decrease, so the money supply decreases.

Question

Quizplus · Accepted Answer

When the Bank of Canada buys government bonds, funds are transferred from the Bank of Canada to the selling banks. These funds increase the reserves of the banking system, leading to an increase in the lending capacity of the banks. The banks, in turn, can create new loans, resulting in an increase in the money supply. Therefore, the correct answer is A: The reserves increase, so the money supply increases.

When the Bank of Canada Buys Government Bonds, How Do