Question

If the Fed wanted to slow down the economy, what would happen to the Federal Funds rate and to open market operations (buy or sell securities)?

Answer 1

The FOMC is altering the pace of fed funds to control inflation and maintain healthy growth. The FOMC members watch for signs of inflation or recession on the economic indicators. The core inflation rate is key indicator of inflation. Durable goods report is the critical indicator for a recession. The Fed's calling contractionary monetary policy when it raises rates. A higher rate of fed funds means banks are less in a position to borrow money to keep their assets at the required amount. As a result they are lending out less money. The money they give is going to be at a higher rate, because they borrow money at a higher rate of fed funds.

Since loans are more difficult to obtain, and more costly, companies are less likely to borrow. That will slow the economy down. Adjustable-rate mortgages will become more costly when that happens. Homebuyers can afford only smaller loans, which slows the housing sector. Housing prices fall. Homeowners in their homes have less equity, so feel weaker. They spend less, thus slowing the economy even further.

When the FOMC aims to boost the federal funds rate and slow the economy, the Fed adopts a contractionary monetary policy. The Fed sells government securities to individuals and institutions, diminishing the amount of money left to lend to commercial banks. It raises borrowing costs, which increases interest rates, including the pace of federal funds. When debt costs rise, individuals and businesses will be discouraged from borrowing and will opt to save their money. Higher interest rates mean higher interest on savings accounts and deposit certificates (CDs), too.