California Real Estate Practice Exam

In a period of tight money, the Federal Reserve Bank can increase the supply of money by:

1. Increasing member bank reserve requirements

2. Lowering member bank reserve requirements

3. Raising the discount rate charged to member banks

4. Selling bonds on the open market

The correct answer is: Increasing member bank reserve requirements

In a period of tight money, the Federal Reserve Bank aims to inject more liquidity into the banking system to facilitate lending and economic activity. The correct way to achieve this is by lowering member bank reserve requirements. When the Federal Reserve lowers the reserve requirements, it permits banks to hold fewer reserves against deposits, allowing them to lend more of their deposits to borrowers. This increase in available funds can lead to lower interest rates and encourage borrowing and spending within the economy. Raising member bank reserve requirements would tighten the money supply further, contrary to the goal of increasing liquidity during a tight money period. Similarly, raising the discount rate would also discourage borrowing from the Federal Reserve, constraining the money supply. Selling bonds on the open market takes money out of circulation, which would also oppose the goal of increasing money supply. Thus, lowering reserve requirements is the appropriate action to expand the money supply in this context.