Question

The Federal Reserve (or Fed) often executes its policy by selling or buying U.S. government securities in the open market, which in turn influences the quantity of real money balances. (a) Show how the sale of U.S. government securities would be consistent with an increase in the interest rate on those securities. (b) How would the yield to maturity on other securities be affected

Answer 1

Answer:

a) When interest rates on U.S. government securities increases, then the Federal Reserve sells those securities in the open market in order to decrease the money supply. This is contractionary monetary policy of the Federal Reserve. As interest rates are indirectly affected by open market operations, the Federal Reserve sells securities on the open market to reduce the amount of money in circulation to combat rising inflation in the economy.

(b) The federal funds rate, the interest rates charged on the loans to individuals and firms and the rates of bank deposits will increase. As a result, the demand for bank deposits will increase and the demand for other debt securities will decrease. This in turn will increase the yield offered on these instruments.