How does the Federal Reserve reduce the money supply?

The Federal Reserve reduces the money supply primarily by selling securities in the open market. When the Fed sells government securities, it takes money out of circulation. Investors, such as banks or private individuals, must pay for these securities, which results in a decrease in the amount of liquid money available for lending or spending in the economy. This action effectively reduces the funds that banks have on hand, leading to a contraction of credit and a tighter money supply overall.

In addition to selling securities, the Federal Reserve can exert influence on the money supply through various means, such as adjusting reserve requirements or altering the discount rate. However, selling securities is a direct and commonly used method to achieve a reduction in the money supply. By removing money from the system through this mechanism, the Fed can help control inflation and maintain economic stability.