Question

In: Economics

Assume a reporter said, “Today the Fed lowered the federal funds rate from 5.5 percent to...

Assume a reporter said, “Today the Fed lowered the federal funds rate from 5.5 percent to 5.25 percent,” a more specific account of the Fed’s action would be as follows:

“Today the Fed told its bond traders to conduct open-market operations in such a way that the equilibrium federal funds rate would decrease to 5.25 percent.”

“Today the Fed lowered the discount rate by a quarter of a percentage point, and this action will force the federal funds rate to drop by the same amount.”

“Today the Fed took steps to decrease the money supply by an amount that is sufficient to decrease the federal funds rate to 5.25 percent.”

“Today the Fed took a step toward contracting aggregate demand, and this was done by lowering the federal funds rate to 5.25 percent.”

Solutions

Expert Solution

Here, the more accurate description, or a more specifc accont is the second option:

2) “Today the Fed lowered the discount rate by a quarter of a percentage point, and this action will force the federal funds rate to drop by the same amount.”

Explanation

The discount rate is the rate at which the banks borrow from the Fed. The Fed only controls the Federal discount rate.

If this rate is lower, the Federal funds rate automatically gets lowered - this is the rate at which banks borrow from each other.

Now, lets see why the other options are incorrect:

1) “Today the Fed told its bond traders to conduct open-market operations in such a way that the equilibrium federal funds rate would decrease to 5.25 percent.”

The Fed doesn't have bond traders to conduct open-market operations on its behalf, and neither does it affect the federal funds rate. The Fed directly changes the discount rate.

3) “Today the Fed took steps to decrease the money supply by an amount that is sufficient to decrease the federal funds rate to 5.25 percent.”

Decreasing money supply would have increased the federal funds rate.

4) “Today the Fed took a step toward contracting aggregate demand, and this was done by lowering the federal funds rate to 5.25 percent.”

Lowering the federal funds rate will actually expand aggregate demand.

Rahul Sunny answered 6 months ago
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