620 PART TEN MONEY AND PRICES IN THE LONG RUN Open-Market Operations As we noted earlier, the Fed conducts open-market operations when it buys or sells government bonds from the public. To in-crease the money supply, the Fed instructs its bond traders at the New York Fed to buy bonds in the nation’s bond markets. The dollars the Fed pays for the bonds in-crease the number of dollars in circulation. Some of these new dollars are held as currency, and some are deposited in banks. Each new dollar held as currency in-creases the money supply by exactly $1. Each new dollar deposited in a bank in-creases the money supply to an even greater extent because it increases reserves and, thereby, the amount of money that the banking system can create. To reduce the money supply, the Fed does just the opposite: It sells govern-ment bonds to the public in the nation’s bond markets. The public pays for these bonds with its holdings of currency and bank deposits, directly reducing the amount of money in circulation. In addition, as people make withdrawals from
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