The fed’s use of open market operations affects banks’ a)interest rates. b)money available to lend. c)lending practices. d)stability.

The correct answer is B.

Open market operations are conducted by central banks and they consist on purchasing/selling national public debt. When debt is purchased, the central banks pays some money for it, and this money that was previously kept as central bank reserves, is now pumped into the economy, hence, put in circulation. On the other hand, when the central bank sells debt it keeps the money paid for it, and the money in circulation, which is also the money available to lend, decreases.

Secondly, the variations of the money supply will affect the price of money, hence, the interest rates, but is not the fundamental objective of open market operations.

The correct answer is option (B).

The Federal Reserve uses open market operations to control the money available to lend.

Further Explanation:

Open Market Operations:

Open market operation is a type of strategy wherein the Federal Reserve purchases and sells government securities in an open market (available to the public) to regulate the money supply in an economy. When the Federal Reserve evaluates that there is enough money supply in an economy, it tends to lower the interest rates, and a large amount of borrowing and lending takes places which results in depreciation of the currency. So to control this situation, the Federal Reserve sells the government securities in the open market so that people invest in those securities and the money supply in an economy decreases and which results in the increase of interest rates and restricting the investors to borrow money and the money supply decreases.

Justification for the correct and incorrect options:

A)

Interest Rates: The interest rates are affected when the Fed uses open market operations to regulate the money supply. Although, it is the part of the strategy to use open market operations for changing the interest rates but to say that the main motive of open market operations is to affect the interest rate is wrong. Sometimes, the Fed has to regulate the money supply to control the interest rates, but the overall impact of the strategy is to have control over the money available in an economy.

Therefore, this option is incorrect.

B)

Money available to lend: The primary purpose of using the open market operations is to regulate the supply of money in an economy because the Fed sells or purchases the government securities to regulate it. When there is a need to sell these securities people of the economy altogether tries to buy them because it is the risk-free investment with good ROI. So people without hesitating invest in these securities resulting in decreasing the money supply.

Therefore, this option is correct.

C)

Lending practices: The practice of lending money to the one who is in need (usually business) by the person who is in excess of those funds (individual with high income) is the change of hands of the money resulting in the income for the lender in the form of interest. But to have the excess of funds with the lender, there must be enough supply of money in the market. Although, the Fed uses the strategy of open market operations to have an effect on any of these outcomes but altogether, its only effect is on the supply of money.

Therefore, this option is incorrect.

D)

Stability: It is impossible for an economy to be stable for a long period because there are many reasons due to which the economy is affected. These reasons could be monetary as well as non-monetary, but it is the duty of the government to try to reduce the bad effects on the economy so that the economy can get into better shape, resulting the stability of the economy. But open market operations cannot be the only solution for the stability of an economy.

Therefore, this option is incorrect.

Learn more:

1. Learn more about the span of control

2. Learn more about the role of money

3. Learn more about the cash deficiency

Answer details:

Grade: Senior School

Subject: Economics

Chapter: Money Supply

Keywords: Open market operations, money supply, interest rates, government securities, lender, business, investor, savings, stability.

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