Question

Federal Reserve monetary policy strives to bring about full employment and price stability. Explain how the Federal Reserve loosens or tightens monetary policy through open market operations and how this affects the economy. Include in your answer how looser or tighter monetary policy affects the amount of reserves in the banking system and interest rates, and how loose or tight monetary policy is supposed to affect GDP, employment and inflation.(8-12 sentences)

Answer 1

Federal Reserve major responsibility is to attain economic growth by bringing stability in prices. Nations have to pass through business cycles. At the time of recession, when there is no income, output and employment is there in the economy . At that time , federal reserve’s make use of expansionary monetary policy. To apply expansionary monetary policy federal reserve buys government securities and release liquidity in the economy. Federal reserve when use open market operations then liquidity in banks increased and create credit. Due to increase in money supply, interest rate falls and real GDP increases. Because investment and interest rate are inversely related. With fall in interest rate , investment increases and increase in investment increase real GDP , income output and employment in economy and recessionary situation come under control.

On the other hand ,At the time of boom, when there is excess of income , output and employment is there in the economy .Inflation exists in the economy because increase in demand now increases inflation not employment. At that time, federal reserve’s make use of contractionary monetary policy. To apply contractionary monetary policy Federal Reserve sells government securities and absorb liquidity from the economy. Federal reserve when use open market operations then liquidity in banks decreased and create credit fall. Due to decrease in money supply , interest rate s increase and real GDP becomes stables and again reach to potential level . Because investment and interest rate are inversely related. With increase in interest rate , investment start decreases due to pessimism .Prices come under control .