Answer to Question #248112 in Macroeconomics for Starr

Question

How would the purchase of bonds by the central bank from local banks be likely to affect

interest rates? How about the effect on interest rates of the sale of bonds? Explain.

Answer 1

When the central bank buys bonds from local banks, the prices of the bonds will rise which in turn reduces the interest rates. The local bank where the central bank bought the bonds from will have more cash which increases the money supply hence making the money less valuable and reduces the interest rates in the money market.

If the central bank sells the binds, there will be a decrease in the money supply through removing cash from the economy in exchange for bonds. The interest rates here will increase because the prices are pushed down.