Question

Explain the Federal Open Market Committee’s choice to lower the Federal Funds Rate and how it impacts the economy. Describe how this action impacts bank reserves, how this changes the loanable funds market (be sure to mention interest rate and lending levels and use a supply and demand model if its helpful), and business and consumer borrowing and spending. You can assume that leakages are minimal.

Answer 1

Federal Funds Rate & Economy

Federal fund rates refers to the interest rate which is a targeted one fixed by FOMC(Federal Open Market Committee) at which commercial banks lend and borrow their excess reserves between each other. It is the rate which is not fixed by the FOMC but suggests the target to be met. Banks within their negotiations fixes a rate of interest which is close to the target rate. The federal rate has effects on controlling the economic activities at various stages of the economy. It may influence short term consumer loans and also have impact in the stock market.

A reduction in the federal fund rates is about to manage an economic recession in the economy. The reduced fund rates can increase the availability of money in the economy and boosting the growth. Rather than forcing the banks to fix an exact federal funds rate, they suggest a target rate where the economic situation could be managed. The Federal Reserve could change the supply of money so that the federal funds rate could move to the targeted rate. The federal funds rate is reduced to tackle a recession in the economy. Reducing the federal funds rate could encourage consumers to avail loans at reduced interest rates. The reduction in the rate helps the banks to keep the reserves reduced thus lending more money to the public which in turn stimulates investment. The effect of federal funds rate in the stock market is also high. A reduction will helps the market to leap higher as the borrowing rate reduces which further helps in investing. Thus the reduction in the rate of federal funds will stimulate business by increased borrowings and spending in the economy.