If the Fed wanted to shift to a restrictive monetary policy and reduce the money supply, it could
A) decrease the reserve requirements imposed on commercial banks.
B) purchase U.S. government securities and other financial assets in the open market.
C) decrease the interest rate on loans extended to banks and other financial institutions.
D) increase the interest rate paid on excess reserves encouraging banks to hold excess reserves rather than extend more loans.

Question

Quizplus · Accepted Answer

In order to reduce the money supply, the Fed would want to encourage banks to hold excess reserves rather than extend more loans. One way to do this is by increasing the interest rate paid on excess reserves. This would make it more attractive for banks to hold on to their excess reserves rather than loaning them out, which would in turn reduce the amount of money circulating in the economy. Decreasing reserve requirements (choice A) would actually increase the amount of money in circulation. Purchasing government securities (choice B) and decreasing interest rates on loans (choice C) would also stimulate lending and increase the money supply, which is the opposite of what the Fed wants to achieve with a restrictive monetary policy.

If the Fed Wanted to Shift to a Restrictive Monetary