6 .How can the federal reserve bank use monetary policy to control the two econo
ID: 2441480 • Letter: 6
Question
6.How can the federal reserve bank use monetary policy to control the two economic issues of inflation and unemployment? EXPLAIN. (10 POINTS)
7. Not all investors are interested in accepting extra risk in order to receive a higher return. Investors can be classified as risk adverse, risk neutral, or risk seeking. To determine the risk associated with an investment, calculations are made to determine the risk-free rate and the risk premium associated with the investment.
Security 1
Security 2
Security 3
Risk-free Rate of Interest
3.00%
3.00%
3.00%
Various Risk Rates
Interest Rate Risk
1.00%
1.50%
1.25%
Credit Risk
0.50%
0.25%
0.25%
Inflationary Risk
0.50%
0.50%
0.50%
Liquidity Risk
0.25%
0.25%
0.50%
Market Risk
0.50%
0.50%
0.50%
Business Risk
1.25%
0.50%
1.50%
Security 1
Security 2
Security 3
Risk Premium
Nominal Rate of Interest
Expected Annual Return*
QUESTIONS:
Fill in the blank spaces for risk premium, nominal rate of interest and expected annual return.
*What is the minimum about of interest an investor would require for each of these securities.
Security 1
Security 2
Security 3
Risk-free Rate of Interest
3.00%
3.00%
3.00%
Various Risk Rates
Interest Rate Risk
1.00%
1.50%
1.25%
Credit Risk
0.50%
0.25%
0.25%
Inflationary Risk
0.50%
0.50%
0.50%
Liquidity Risk
0.25%
0.25%
0.50%
Market Risk
0.50%
0.50%
0.50%
Business Risk
1.25%
0.50%
1.50%
Security 1
Security 2
Security 3
Risk Premium
Nominal Rate of Interest
Expected Annual Return*
Explanation / Answer
(6)
During an economic expansion (the "boom" phase), inflation is high and unemployment rate is low. To prevent the economy from over-heating, the Fed uses contractionary monetary policy to lower aggregate demand and tame inflation. This is implemented by open market sale of federal securities, and/or by increasing discount rate, and/or by increasing the required reserves ratio, to decrease money supply to decrease aggregate demand and to lower inflation rate. But this policy, by reducing output, will increase unemployment rate, thus there is a trade-off.
In contrast, during an economic recession, inflation is low and unemployment rate is high. To lower unemployment by boosting aggregate demand, the Fed uses expansionary monetary policy to increase aggregate deand. This is implemented by open market purchase of federal securities, and/or by decreasing discount rate, and/or by decreasing the required reserves ratio, to increase money supply to increase aggregate demand and to lower unemployment rate. But this policy, by increasing output and aggregate demand, will increase inflation rate, thus there is a trade-off too.
NOTE: As per Chegg Answering Policy, first question has been answered.
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