<p>Okay, so there’s a macroeconomics question I’m clueless about, and I was wondering if you guys could help me, so here it is:</p>
<p>“Explain how the Fed could increase the level of bank reserves in the economy while leaving the money supply unchanged.”</p>
<p>I know that the Fed could raise the reserve requirements, but that would lower the money supply…anyone?? Help!</p>
<p>You are halfway there. The Fed really only has 2 tools at its disposal: Bank reserve requirements and short term interest rates. As you said, “they could raise reserve requirements, but that would lower the money supply.” Then, in addition to raising reserve requirements they could lower the Fed Funds rate to leave the money supply unchanged. By exactly how much, I have no idea!</p>
<p>Raising the reserve requirement lowers the money supply.</p>
<p>To offset that, the Fed can buy bonds. Fed purchase of bonds increases the money supply. </p>
<p>In theory, the amount of bonds bought can be chosen to offset exactly the effect of the increase in reserve requirements.</p>
<p>
To add on to the other responses… The Fed does not change the money supply because they change the bank reserves by buying or selling bonds–not by creating money. If the Fed buys $XXX worth of bonds from a bank, the bank gets $XXX available money to use (cash, in effect) and the Fed gets that much in government bonds. The value of money that the bank has is the same before and after the transaction. It has simply changed form from bonds, which cannot be used as money to invest, to “cash” money which can be used in any way.</p>
<p>And with the multiplier effect of around 2.5-3.0 the impact is compounded greatly.</p>
<p>Thank you guys for being so helpful…I think that I’m going to use your suggestion, ADad - it makes sense to me, and there’s nothing else that I can think of (all one-step processes seem to be either expansionary or contractionary), so thank you so much. This one stumped me because I guess I was thinking too mechanically and not “using” what I’ve learned - eh, I guess macroeconomics just isn’t my thing:/</p>
<p>ADad gave you the correct answer. Increasing reserve requirements will shrink the money supply and cause interest rates to go up. I said they would then lower the fed funds rate, but they can’t just wave their arms and lower rates. They would have to implement the policy by buying bonds, as ADad said.</p>