If the demand for money increases and the Fed wants interest rates to remain unchanged, which of the following would be appropriate policy?
A) recall Federal Reserve Notes from circulation
B) raise the legal reserve requirement
C) buy bonds in the open market
D) raise the discount rate

Question

Quizplus · Accepted Answer

If the demand for money increases, it means that people and firms are willing to hold more money at any given interest rate. If the Fed wants interest rates to remain unchanged, it needs to increase the supply of money to meet the increased demand. One way to do that is by buying bonds in the open market, which injects money into the economy and lowers the yield (interest rate) on those bonds. Therefore, the correct policy in this situation is to buy bonds in the open market. The other options are either irrelevant (recall Federal Reserve Notes) or would lead to higher interest rates (raise legal reserve requirement or raise the discount rate).

If the Demand for Money Increases and the Fed Wants