Chapter 10, Problem 2P

To determine

To discuss the difference in the impact on money supply due to using a fiscal surplus to buy back bonds and using open market operations to buy them.

Explanation of Solution

When tax receipts are used to purchase bonds and then to pay off the debt, the money supply remains unaffected. This is because money is only transferred from the tax receipts to the interest payments of debt. The money that is received from the economy through tax payments flows back to the economy as payment for the purchase of bonds. However, when the bonds are purchased using open market operations, the transactions occur in printed currency. Thus, the reserves of the economy increase, thereby leading to an increase in the money supply.

Economics Concept Introduction

Concept introduction:

Money supply: Money supply refers to the total amount of monetary assets circulating in an economy during a particular period of time.

Open market operation (OMO): It is the monetary control mechanism employed which involves the buying and selling of government securities in the open market to routine (expand or contract) the amount of money in the banking system.