An open market purchase by the Fed does what? A) decreases the supply of money B) increases the supply of money C) decreases the demand for money D) increases the demand for money

What this question is testing

You need to know how the Federal Reserve’s open market operations affect bank reserves and, in turn, the money supply.

What happens in an open market purchase

When the Fed makes an open market purchase, it buys government securities from banks or the public. The Fed pays by creating reserves (crediting bank accounts at the Fed).

How that changes the money supply

More reserves in the banking system mean banks can make more loans. With fractional reserve banking, new loans create new deposits, so the overall money supply increases.

Choosing the correct option

• B is correct: the money supply increases.
• A is wrong: a purchase does not drain reserves, it adds them.
• C and D are wrong: open market operations primarily shift the supply of money, not the demand for money (demand is driven by income, prices, interest rates, and preferences).