When the Fed sells bonds, the: balances in bank accounts are increased, which dr

Question

When the Fed sells bonds, the:

balances in bank accounts are increased, which drains central bank reserves from the system causing the federal funds rate to increase

balances in bank accounts are reduced, which drains central bank reserves from the system causing the federal funds rate decline. This reduces short term interest rates in the economy.

balances in bank accounts are reduced, which adds central bank reserves to the system causing the federal funds rate to decrease

balances in bank accounts are reduced, which drains central bank reserves from the system causing the federal funds rate to increase

Explanation / Answer

When the Fed sell bonds then purchaser of such bonds pays for these through their bank accounts.

So, balances in bank accounts decreases.

Secondly, through selling of bonds, Fed reduces the supplpy of reserves in the banking system.

Given the demand for reserves, this decrease in supply of reserves leads to an increase in federal funds rate.

So,

When the Fed sells bonds, the balances in bank accounts are reduced, which drains central bank reserves from the system causing the federal funds rate to increase.

Hence, the correct answer is the option (4).

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