What action does the Federal Reserve take to contract the money supply?

The Federal Reserve contracts the money supply as part of its monetary policy strategy to control inflation and stabilize the economy. Selling securities to banks is a key mechanism for achieving this contraction. When the Fed sells securities, banks pay for these securities, which reduces the amount of reserves they have on hand. As a result, banks have less money to lend, which leads to a decrease in the overall money supply in the economy.

This action effectively raises the cost of borrowing, as fewer reserves available to banks typically lead to higher interest rates. Consequently, by selling securities, the Fed can manage liquidity in the banking system and influence economic activity, aligning with its goals of maintaining price stability and full employment. The other actions listed, such as reducing interest rates and purchasing government bonds, would actually expand the money supply rather than contract it.