If the Fed makes open market purchases of bonds,
A) the money supply increases by more than the amount of bonds purchased.
B) the money supply increases by less than the amount of bonds purchased.
C) the money supply decreases by more than the amount of bonds purchased.
D) the money supply decreases by less than the amount of bonds purchased.

Question

Quizplus · Accepted Answer

When the Fed makes open market purchases of bonds, it creates new money to pay for them. This new money enters the banking system, leading to an increase in the money supply. However, the increase in the money supply is not limited to the amount of bonds purchased because of the money multiplier effect. Banks will lend out a portion of the new reserves they receive, which in turn increases the money supply even further. Hence, the money supply increases by more than the amount of bonds purchased.

If the Fed Makes Open Market Purchases of Bonds