Question

If money demand shifted to the left and the Federal Reserve desired to return the interest rate to its original value, it could__________.a)buy bonds to decrease the money supply.b)buy bonds to increase the money supply.c)sell bonds to increase the money supply.d)sell bonds to decrease the money supply.

Answer 1

Answer:

The correct answer is option d.

Explanation:

A leftward shift in the money demand curve would cause the demand for money to decline. As a result, the interest rate will fall and the equilibrium quantity of money will decline as well.  

If the Fed wants to restore the interest rate to its original value, it has to decrease the money supply.  

It needs to adopt a contractionary monetary policy. The fed can sell bonds in the open market, the payment made by the sellers will be deducted from their bank accounts.  

This will decrease the reserves of the bank. This further decreases their lending capacity. As the supply of money decreases, the interest rate will increase.