If your local bank buys a few billion dollars worth of government secu

If your local bank buys a few billion dollars worth of government securities, what happens to the economy’s money supply?

What will be an ideal response?

ANSWER

If the seller of the bonds is another private business, there is no effect on the money supply. The money that might have supported spending and lending by the buying bank is now available for lending and spending by the seller(s) of the bonds. However, if the seller of the bonds is the Federal Reserve, then the money supply is reduced, since the decline in liquidity at the buying bank is not offset by an increase in liquidity elsewhere in the economy. (The bank’s deposit at the Fed is reduced by the amount of its bond purchase; the money is not transferred to a different account, but ceases to exist.)