If we consider only the direct (initial) balance sheet effect of open market ope
ID: 1210792 • Letter: I
Question
If we consider only the direct (initial) balance sheet effect of open market operations involving the purchasing of bonds by the Fed from financial institutions (commercial banks):
A. banks' reserves will decrease, while their bond holdings will increase, overall increasing the total amount of assets.
B. banks' assets are not going to be affected, only their liabilities.
C. banks' total assets are going to increase, while banks' liabilities will decrease.
D. banks' reserves will increase, while their bond holdings will decrease, but overall the total amount of assets does not change.
E. banks' reserves will increase, while their bond holdings will decrease, overall reducing the total amount of assets.
Explanation / Answer
Suppose Federal Reserve purchases $100,000 worth of Treasury Securities from AAA Securities.
To pay AAA, the Fed deposits AAA’s Bank's reserve account for $100,000 in its bank called FBU. FBU then credits AAA's checking account with a $100,000 deposit. The Fed's purchase has thus introduced $100,000 new reserves in the banking system. So on one side assets are reduced and on the other reserves are increased by the same amount so that their is no change in total assets.
So option D is correct