Question

The Federal Reserve affects the money supply ( ) by ()

A. indirectly; changing the amount of reserves, which turn into deposits.

B. indirectly; changing the amount of deposits, which turn into reserves.

C. directly; changing the amount of deposits, which turn into reserves.

D. directly; changing the discount rate.

Answer 1

Option A.) indirectly; changing the amount of reserves, which turn into deposits.

The Federal Reserve affects the money supply in the economy indirectly because it does not have a direct control on the money supply of a nation.

So, it changes the reserve requirements of how much percentage of deposits the commercial banks must hold with the Federal Reserve. If the Federal Reserve wants to increase the money supply, it can do so, by decreasing the reserve requirements of the commercial banks so that more money is available in the hands of the commercial banks to lend to the general public which in turn leads to more money supply. On the other hand, if the Federal Reserve wants to decrease the money supply, it can do so, by increasing the reserve requirements of the commercial banks so that less money is available in the hands of the commercial banks to lend to the general public which in turn leads to less money supply.