GED Social Studies TestEconomicsMedium
A country's central bank decides to sell a significant amount of government securities on the open market. Which of the following is the most likely immediate effect of this action on the money supply and interest rates?
- AMoney supply decreases, interest rates increase.
- BMoney supply increases, interest rates decrease.
- CMoney supply increases, interest rates increase.
- DMoney supply decreases, interest rates decrease.
Show answer & explanationAnswer & explanation
Correct answer: A. Money supply decreases, interest rates increase.
When the central bank sells government securities, it takes money out of circulation from commercial banks. This reduces the money supply. A reduced money supply makes money scarcer, leading to higher interest rates as borrowing becomes more expensive.
Why the other options are wrong
- B. Selling securities removes money from the economy, decreasing the money supply and increasing interest rates.
- C. Selling securities contracts the money supply, and increased interest rates are a consequence of a contracted money supply.
- D. Selling securities contracts the money supply, but this typically leads to increased, not decreased, interest rates.
Open Market Operations (OMO)
The buying and selling of government securities in the open market by a central bank to expand or contract the amount of money in the banking system.
- Primary tool of monetary policy.
- Buying securities injects money into the economy.
- Selling securities removes money from the economy.
Memory trick: Central banks twist the money dial, affecting rates for a while.