Question

97. J6 the Federal Reserve felt the economy was growing too aggressively explain what action they might take through open market operations? Be sure to explain why.

Answer 1

If the economy is growing too aggressively, the economy faces the risk of overheating and inflation. Therefore, the Fed will seek to slow down the growth so that the growth rate is not too aggressive.

To achieve this, the Fed may conduct open market operations. That is, the Fed will sell bonds in the open market. This will take some of the money supply out of circulation from the economy. This would in turn result in rising interest rates, as the interest rates are determined by supply and demand of money. The demand has not changed, but the supply has decreased due to bond purchases by banks and other financial institutions, causing higher interest rates. Due to higher interest rates, consumption and investment would decrease in the economy, as it is more expensive for consumers and businesses to borrow. This would finally cause the growth rate of the economy to slow down.