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Effect of a Bond Purchase on a Bank's Balance Sheet

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Assume that this balance sheet portrays the state of the banking system. The banks have no excess reserves.

Assets Liabilities
Total reserves Transactions accounts
$40 billion $160 billion
Loans
$50 billion
Securities
$70 billion

Total Total
$160 billion $160 billion

1. The Federal Reserve buys $10 billion of bonds from a bond dealer. What is the initial impact of the transaction?
A. The banking system's holdings of securities rise by $10 billion and the banking system's total reserves fall by $10 billion.
B. Transactions accounts rise by $10 billion and the banking system's total reserves rise by $10 bill
C. The banking system's holdings of securities fall by $10 billion and the banking system's total reserves rise by $10 billion.
D. Transactions accounts rise by $10 billion and the banking system's holdings of securities rise by $10 billion.

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Solution Summary

This solution explains how the banking system's assets and liabilities are affected by an open market bond purchase by the Federal Reserve, and how the transaction will affect the money supply.

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1. The answer is C. The Fed puts $10 billion of reserves into the banking system in exchange for $10 billion ...

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