Question

A sale of securities by the Fed causes

Answer 1

Answer:

D) A multiple contraction of the money supply greater than the amount of the securities sold.

Explanation:

When the fed sells securities in the open market, it obtains dollars, and keeps those dollars from circulating, in other words, in reduces the money supply.

The contraction in the money supply is greater than the amount of securities sold because of the money multiplier.

When the fed sells securities, it reduces the monetary base, which is equal to:

B = C + D

Where:

B = Monetary base

C = Cash in hands of the public

D = Demand deposits

And the money supply is equal to:

M = m x B

Where:

M = money supply

m = money multiplier

B = Monetary base

Because of the money multiplier, any contraction or expansion in the monetary base has a multiplying effect in the money supply.