Question

If the Treasury pays a large bill to defense contractors and as a result its deposits with the Fed fall, what defensive open market operations will the manager of the open market desk undertake?

Short answer

Open market sale of government securities is the operation the manager of the open market desk will be undertaken when the Treasury pays a large bill to defense contractors and its deposits with the Fed fall.

Step-by-step solution

Concept Introduction

The Treasury has drawn on its deposits with the Fed to pay a large bill to defense contractors. The open market operations that will offset the impact of this transaction on money supply are required to be stated.

Explanation

As the Treasury draws on its deposits to pay a bill to contractors, the bank accounts of contractors get credited.

This increases the reserves with the commercial banking sector. The money supply has already expanded as the number of deposits in the commercial banking method has improved.

Further, the money supply will rise even more as the banks will start to lend out the excess reserves they hold now.

Final Answer

Therefore, to offset the increase in money supply, the manager of the open market desk can undertake theOpen market sale of government securitiesand bring the amount of the reserve with the commercial banking sector back to its initial level.