The Federal Reserve plans to purchase bonds because the unemployment rate is not looking favorable and...

The Federal Reserve plans to purchase bonds because the unemployment rate is not looking favorable and there are evidences of impending recession. How does this action affect the money supply? What happens to the interest rates? Explain using a graph.

Expert Solution

When Fed plans to purchase the bonds, then it is going to increase the money supply in the market. It causes decrease in the interest rate. It causes decrease in the cost of borrowings for households and firms. So, consumption and investment spending increase in the economy. As a result, AD increases and it causes real GDP to increase and unemployment to decrease. It solves the problem of rising unemployment and looming recession.

It is shown by the graph representing money market.

Above graph shows that when money supply increases from Q1 to Q2, then interest rate decreases from I1 to I2.

Rahul Sunny answered 2 years ago

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