Suppose the that the Central Bank decides to buy back more assets through open market operations....

Suppose the that the Central Bank decides to buy back more assets through open market operations. Would this policy aim to stimulate or contract the economy? In addition, would interest rates be affected? Make sure to include in your answer a description of how changes in interest rates affects the supply and demand of interest-earning assets.

Expert Solution

If the central bank wants to buy back more assets through open market operations,its using a cheap ( expansionary) monentary policy to facilitate economic expansion.

An expansionary monetary policy aims to increase money supply in an economy. When central bank purchases assets, there is a transfer of money from central bank to the sellers of assets . Result is an rise in money supply in the economy.

This transaction also has an another side.Open market purchased by the central bank rises bond prices . There is an inverse relationship between interest rates and bond prices. Rise in bond prices leads to a fall in in interest rates.

When interest rates fall credit becomes cheaper. Consumption and investment activities based on borrowed credit increases in the economy. Consumption and investment are important components of aggregate demand. Higher consumption and investment results in an increase in aggregate demand. Production in the economy rises so that aggregate supply is matched with aggregate demand. All these activities together set the economy on the path of economic expansion.

Rahul Sunny answered 2 years ago

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