Question

The central bank requires Southern to hold 10% of deposits as reserves. Southern Bank's policy prohibits it from holding excess reserves. If the central bank sells $25 million in bonds to Southern Bank which of the following will result?
A. the money supply in the economy decreases
B. Southern's net worth increases by $25 million
C. decrease in Southern's bond assets by $25 million
D. increase in Southern's loan assets of $25 million

Answer 1

The money supply in the economy decreases.

Answer: Option A

Explanation:

The central bank of the country has certain measures which can control the supply of the money in the economy. One of those measures is to buy and sell bonds in the market.

If the central bank sells bonds to the other banks, it will result in the decrease in the supply of the money in the market because the reserves in the bank also reduces. The bank purchases the bonds from the central bank and thus the reserves decrease.