The Fed can offset the effects of an increase in float by engaging in
A. a matched saleminus−purchase transaction.
B. an open market purchase.
C. an interest rate swap.
The correct answer and explanation is:
The correct answer is B. an open market purchase.
Explanation:
An increase in float refers to the period of time between when a deposit is made and when the funds become available for withdrawal. This can happen when there is a delay in processing checks or when the banking system has inefficiencies. When float increases, it can cause an increase in the effective money supply in the economy, as funds that are technically not yet available still circulate and impact liquidity.
The Federal Reserve (the Fed) can offset the effects of an increase in float by conducting an open market purchase. This involves the Fed buying government securities, typically Treasury bills, from the open market. By doing this, the Fed injects money into the banking system. When the Fed buys securities, it credits the accounts of the commercial banks selling those securities with additional reserves. These reserves increase the bank’s ability to lend money, which can help maintain the desired level of money supply and keep interest rates stable.
The other options listed are not the best ways to offset the effects of an increase in float:
- A. A matched sale-purchase transaction is a short-term transaction where the Fed sells securities and agrees to repurchase them later. This operation is used to drain reserves from the banking system, which is not appropriate for offsetting an increase in float.
- C. An interest rate swap is a financial derivative where two parties exchange interest payments. While it can affect the broader economy, it is not typically used by the Fed to directly manage money supply changes due to float increases.
- D. A repurchase agreement (repo) is a short-term borrowing agreement where banks sell securities to the Fed with an agreement to repurchase them. While repos do inject liquidity into the system, they are usually used for short-term liquidity management rather than offsetting longer-term changes in the float.
Thus, an open market purchase is the correct tool for the Fed to counteract the effects of an increase in float and maintain control over the money supply and interest rates.