When the Fed buys government bonds, the reserves of the banking system

Question

a. decrease, so the money supply decreases.
b. increase, so the money supply decreases.
c. decrease, so the money supply increases.
d. increase, so the money supply increases.

Answer 1

When the Fed buys government bonds, it purchases them from banks or other financial institutions. This transaction increases the reserves of the banking system because the banks receive payment in the form of reserves. As a result, the banks have more reserves available to lend, which increases the money supply.

The correct answer is: d. increase, so the money supply increases.