Open Market Operations

B is correct. When the Federal Reserve purchases Treasury securities through open market operations, it injects money into the banking system, increasing the money supply. This expansionary monetary policy puts downward pressure on interest rates. As interest rates fall, existing bonds with higher coupon rates become more valuable, so bond prices rise (inverse relationship between rates and bond prices). This benefits the client's 70% bond allocation.

A is incorrect because it reverses the direction: Fed purchases lower rates, not raise them. D is also incorrect for the same reason. C is incorrect because open market operations are the primary mechanism by which the Fed influences interest rates throughout the economy, not just bank reserves. The increased money supply from Fed purchases flows through the banking system to all borrowers, affecting rates on mortgages, corporate bonds, and all other debt instruments.

B is correct. The Federal Open Market Committee (FOMC) is responsible for conducting open market operations, the buying and selling of Treasury securities to implement monetary policy. The FOMC meets eight times per year to set monetary policy direction and oversees daily open market operations through the Federal Reserve Bank of New York's trading desk.

A (Board of Governors) sets the discount rate and supervises the banking system but does not conduct open market operations. C (the 12 Federal Reserve Banks) provide banking services and regional economic input, but only the New York Fed's trading desk executes open market operations under FOMC direction. D (Treasury Department) is a separate government entity that issues Treasury securities and manages federal debt, but has no role in monetary policy or Fed operations.

B is correct. When the Federal Reserve sells Treasury securities, banks and dealers purchase these securities by paying the Fed, which removes money from the banking system. This decreases the money supply and reduces bank reserves available for lending. With less money available, the federal funds rate (the rate banks charge each other for overnight loans) increases as banks compete for scarce reserves. This is contractionary monetary policy designed to raise interest rates and slow economic activity.

A is incorrect because selling securities removes (not injects) liquidity from the banking system, which raises (not lowers) rates. C is incorrect because open market operations primarily target the federal funds rate, though the effects ripple through all interest rates including long-term rates. D is incorrect because selling securities reduces (not increases) excess reserves, eliminating the basis for banks to compete by lowering rates.

C is correct (the EXCEPT answer). Open market operations are NOT conducted by Congress and have nothing to do with the federal budget process. This is a critical distinction between monetary policy (controlled by the Federal Reserve through open market operations, discount rate, and interest on reserves) and fiscal policy (controlled by Congress and the President through taxation and government spending). Open market operations are conducted by the FOMC, an independent body within the Federal Reserve System.

A is accurate: open market operations specifically involve buying and selling U.S. Treasury securities (government bonds, notes, and bills) to influence money supply. B is accurate: when the Fed purchases securities, it pays banks and dealers, injecting money into the banking system, which increases money supply and lowers interest rates (expansionary policy). D is accurate: the FOMC meets eight times per year (approximately every six weeks) to review economic conditions and set the target federal funds rate, which is implemented through open market operations.

C is correct. Statements 2, 3, and 4 are accurate.

Statement 1 is FALSE: This is expansionary monetary policy, not contractionary. When the Fed purchases securities, it injects money into the economy to stimulate growth and combat recession. Contractionary policy would involve selling securities.

Statement 2 is TRUE: When the Fed buys $100 billion in Treasury securities, it pays banks and dealers, directly injecting $100 billion into the banking system. This increases the money supply immediately and allows banks to create additional money through lending (money multiplier effect).

Statement 3 is TRUE: Increased money supply from Fed purchases puts downward pressure on interest rates. With more money available to lend, banks compete for borrowers by offering lower rates. The federal funds rate falls, and other rates (mortgages, corporate bonds, consumer loans) typically follow.

Statement 4 is TRUE: During recession with rising unemployment, expansionary monetary policy (securities purchases) aims to stimulate economic growth by making borrowing cheaper, encouraging business investment and consumer spending, and supporting job creation.