CHAPTER 14: THE MONEY SUPPLY PROCESS

Q1. If the Fed sells $2 million of bonds to the First National Bank, what
happens to reserves and the monetary base? Use T-accounts to explain your
answer.

First National Bank

Assets Liabilities
Securities/Bonds +$2M Reserves
Reserves -$2M

For the First nation bank there will be a decrease in reserves by $2 million and an
increase in securities by the same amount.

Federal Reserve System

Assets Liabilities
Securities/Bond -$2M Reserves -$2M
s

For the Federal Reserve System, there will be a decrease in the Reserves and a
decrease in Govt. Securities by $2 million
Selling of bonds by the Fed to the First National Bank leads to a decrease in the
monetary base by $2 million because the level of reserves has fallen by $2 million.