3.a) To counteract an economic contraction, the Federal Reserve (the Fed) often

Question

3.a) To counteract an economic contraction, the Federal Reserve (the Fed) often attempts to stimulate the economy by reducing interest rates. Describe the five-step process that starts with an increase in the money supply and ends with an increase in GDP b) To counteract inflation, the Fed often attempts to dampen economic growth by increasing interest rates. Describe the five-step process that starts with a decrease in the money supply and ends with a reduction in inflation and GDP c) What factors determine the effectiveness of this five-step process? Hint See the Week 7 edition of the TANSTAAFL TRIBUNE Friendly Reminder: Your initial responses (answers) to the DQ's are not considered as participation. Howeves you esponses to classmates answers are considered participation/it you have questions about the Type here to

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1 fed increases money supply by purchasing securities. This frees up bank assets. They now have more money to lend. As a result federal funds rate decreases. Thus cost of credit to banks falls. They inturn reduce their own lending rates. Facing lower interest cost investors invest more in economy. In this way gdp rises

2 The central bank sells security. As a result banks loose money. The federal funds rate rises due to less availability of funds. Thus cost of credit to banks rise. They inturn raise lending rates. This raises cost of investment. As a result investment falls. As investment falls Gdp fall and so does inflstion

3 effectiveness depends on how much developed is securities market. Also banks should not possess excess reserves. The effectiveness also depends how much investment is sensitive to interest rate changes

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