ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -If the Fed buys bonds in the open market, it increases the money supply in the economy by swapping out bonds in exchange for cash to the general public. Conversely, if the Fed sells bonds, it decreases the money supply by removing cash from the economy in exchange for bonds.

Detailed explanation-2: -If the Fed sells government bonds, bank reserves will: decrease, leading to a decrease in the money supply. During an economic slump, policies that lower interest rates may not actually boost investment because: of pessimistic expectations by businesses about the future of the economy.

Detailed explanation-3: -So the first thing that happens with a decrease in the money supply is that interest rates rise. As interest rates rise, businesses are less willing to invest to borrow for investment spending. And consumers, too, are less willing to borrow to buy cars and homes and so on. Thus spending decreases.

Detailed explanation-4: -To decrease the (growth of the) money supply, the Fed could either sell bonds, raise the reserve requirement ratio, or raise the discount rate.

Detailed explanation-5: -Money supply and interest rates have an inverse relationship. A larger money supply lowers market interest rates, making it less expensive for consumers to borrow. Conversely, smaller money supplies tend to raise market interest rates, making it pricier for consumers to take out a loan.