Question

Take a look at the two panels of figure 16.2, and also consider figure 16-1. Suppose that instructions in the latest FOMC Directive call for a monetary policy action aimed at inducing individuals & businesses to demand a smaller quantity of money. Use appropriate panel of figure 16-2 to assist in explaining whether officials at the Federal Reserve Bank of New York's Trading desk should buy or sell bonds.

Short answer

The desk should sell securities to decrease the interest rate in economy.

Step-by-step solution

FOMC Concept 

Federal Open Market Operations means buying & selling of government securities in open market. It is used as a monetary (quantitative) credit control tools.

• Central bank buys securities (giving commercial banks & public cash) - to increase money supply, liquidity in economy.
• Central bank sells securities (getting cash from commercial banks & public) - to decrease money supply, liquidity in economy

Explanation 

Interest rate is the price of money, so it is directly related to money supply.

More money supply implies low interest rates, & less money supply implies high interest rate in the economy.

• So, when central bank sells securities & decreases money supply - it leads to higher interest rates in the economy.

Higher interest rates imply that funds are expensive for households & firms, so their consumption & investment expenditure respectively decrease.