Assignment: Use all of your tools of analysis developed in this course to explai

Question

Assignment: Use all of your tools of analysis developed in this course to explain how the Fed, using open market operations as expansionary monetary policy can fight unemployment.

The story that you tell will thus be in three parts. First, tell completely how the Fed carries out monetary policy using bond trades (financial markets) and the impact this will have on the money supply and interest rates (guidelines for this are in this module). Second, explain the impact this change in rates will have on production, output, spending and the spending multiplier, etc. (goods and services markets). For this part, assume that the monetary policy of the Fed stimulates consumer spending by $100 billion and investment spending by $85 billion. Assume the MPC = .71. Third, tell what impact these changes in output and spending will have on labor markets. Finally, summarize the movements of all key variables:

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Explanation / Answer

The story that you tell will thus be in three parts.

First, tell completely how the Fed carries out monetary policy using bond trades (financial markets) and the impact this will have on the money supply and interest rates (guidelines for this are in this module).

The Fed carries out monetary policy using bond trades (i.e. financial markets) by involving open market operations. They buy and sell U.S. government bonds in the open market. Transaction occur between the trading desk and primary dealers. This group has sufficient amounts of capital that allow for trading bonds with the trading desk. This entire process occurs because of directives created by the FOMC.

The impact that occurs by the Fed carrying out monetary policy using bond trades is two-fold. If the prerogative is to lessen the supply of money, then this is done by reducing the availability of reserves to banks in the federal funds market. This causes scarcity and the rate of the federal fund increases. As a result, this lessens the likelihood of borrowing in the federal funds market. Thus, general banks are disinclined to lend and interest rates rise. However, if the prerogative is to increase the supply of money, then the opposite process occurs. The Feds purchase government bonds, and reserves increase in the open market, ultimately causing interest rates to drop.

Second, explain the impact this change in rates will have on production, output, spending and the spending multiplier, etc. (goods and services markets). For this part, assume that the monetary policy of the Fed stimulates consumer spending by $100 billion and investment spending by $85 billion. Assume the MPC = .71.

We assume that the monetary policy of the Fed stimulates consumer spending by $100 billion and investment spending by $85 billion. The impact on this change in rates will increase production as well as increase output (as indicated in the results of our formula). Spending and the spending multiplier also have an increased outcome. When consumers increase spending, businesses in turn can grow and increase profits. This in turn, allows for an increase need of employees in the work place. More hiring then lowers the unemployment rate. In a time of expansionary monetary policy, businesses are more able to borrow money to expand their operations. In time, more jobs allows for availability of money for consumers and thus spending increases and businesses flourish.

FORMULA: The Change in Output = Change in Spending X 1/(1

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