Economics Question

If households are holding larger real money balances than they desire, which of the following is least likely? A) The opportunity cost of holding money balances will decrease. B) Households will bid up securities prices. C) The interest rate is higher than its equilibrium rate in the market for real money balances. D) The central bank must sell securities to absorb the excess money supply and establish equilibrium. Please justify your answer.

is it C?

I think B. If they are holding cash they are not buying securities.

I would go with C. If the interest rate (the opportunity cost of holding money balances) was higher than equilibrium, households would invest money, not hold it. All other options can happen if household sector decides to reduce excess money balance. As more money comes to the market, opportunity cost would decrease, security prices would increase and central bank could “mop” excess money balances by selling securities with higher interest rates.

I think its B. With cash reserves going up within households, the demand for securities would go down, leading to a fall in security prices.

I will go with D. I don’t believe the job of the central bank is to establish equilibrium in the Money Supply markets. All others seem correct to me.

Holding real money outside the market creates a scarcity that in turn increases investment opportunity costs. A is likely. Households are holding excess real money balances when the return from investing those reserves is below the equilibrium, and in anticipation of rates going up. As soon as rates go up, bidding for securities would bring rates down and prices up. B is likely. Central bank must sell securities to collect the money hanging around outside the market. D is likely. If interest rate would be higher than the opportunity cost of holding money outside the market, households would bid on it. Since household are not, this is the least likely scenario. C is the answer.

Question on C. Households are holding more money than they desire…so wont their demand for money decrease ? This will move us down the demand curve towards lower, equilibrum interest rates which means that we are at a point above equilibrium interest rates making C correct. Where is my thinking flawed?

Households hold the resource (money), they are suppliers, not consumers of money, and not willing to supply because the opportunity cost is low, or opportunity cost of holding money is greater.

Sorry Map… Still not understanding… How are households the suppliers of money? The supply of money is determined by the Fed. Households do not desire real money balances wont interest rates be high?

The official answer is D! The Fed’s actions should not be included here. You need to assess how the market will move to equilibrium independent of monetary policy. All of the other answers describe factors that influence and bring the market to equilibrium.

A is right if interest rates are higher. B is possible, but dont need to buy securities C, People dont hold cash if interest rates are higher. D: Open market operation sounds right, Fed sell securities to control money flow. I agree with answer D.

Doh, maybe if I had read which is LEAST likely I would have got it right!