Now let’s discuss the third tool, which is buying or selling government securities (e.g., U.S. treasury bills). Individuals invest in a treasury bill and the government pays them back the principal with interest. If the economy is performing too well and we want to decrease economic activity, the Federal Reserve will sell government securities. In essence, it opens up the opportunity for investors to buy these securities. Consequently, these individuals and businesses will spend money to buy these securities, leading them to have less money available to spend on purchases. Since they have less money available, the money supply will decrease.

When we want to decrease economic activity, the Federal Reserve sells government securities. When the Federal Reserve wants to increase economic activity, it buys government securities. If it’s buying the securities, people will now have more money available because they sold their investments, enabling them to make more purchases.

Study Tip: Selling government securities decreases the money supply and decreases economic activity. Buying government securities increases the money supply and increases economic activity.