Question

Name at least one action that the Fed could take to reduce the money supply and raise interest rates. Given our current economy, would you recommend that the Fed reduce the money supply and raise interest rates, or expand the money supply and lower interest rates? Please explain.

Answer 1

When a central bank uses its instruments to stimulate the economy, expansionary monetary policy is. This increases the supply of money, lowers interest rates, and increases aggregate demand. As measured by gross domestic product, it boosts production. It lowers the currency's value, thus lowering the exchange rate. It's the opposite of the monetary policy of contraction.Expansionary monetary policy deters the business cycle's contractional stage. Yet capturing this in time is hard for politicians. As a result, expansionary measures are usually used after a recession has ended.

The Committee of the Federal Open Market may also lower the rate of fed funds. For overnight deposits, it's the rate banks charge each other. Each night, the Fed allows banks to keep some of their deposits in reserve at their local branch of the Federal Reserve. Those banks that have more than they need will lend the excess to banks that have not enough to charge the rate of fed funds. It becomes cheaper for banks to maintain their reserves when the Fed drops the target rate, giving them more money to lend.

By modifying reserve requirements, which generally refers to the amount of funds banks have to hold against deposits in bank accounts, the Fed can influence money supply. By lowering the reserve requirements, banks can lend more money, which increases the economy's overall money supply. Through increasing the reserve requirements of the banks, on the other hand, the Fed is able to reduce the size of the money supply. Eventually, by performing open market operations, which influences the federal funds rate, the Fed will influence the money supply. The Fed buys and sells government securities on the open market in regular operations. If the Fed wants to increase the supply of money, it will purchase government bonds. It provides cash to the debt dealers who sell the bonds, increasing the total supply of money.