Question

2. How does the Fed control the federal funds rate? If the Fed wants to lower the federal funds rate, what will it do?

3. When will the Fed want to raise the Federal funds rate? What is the ultimate effect on real GDP and the inflation rate from raising the federal funds rate?

4. Tell the path through which a fall in the federal funds rate affects real GDP and inflation.

5. What role does the multiplier effect play in monetary policy? (This "multiplier" is not the money multiplier nor the government expenditure multiplier. Instead, you'll want to study the graph provided in the text that shows how a change in interest rates affects investment and subsequent rounds of consumption and investment.)

Answer the following multiple choice questions.

6. An open market purchase of government securities ____ the federal funds rate and ____ the supply of loanable funds.

a. raises; increases

b. raises; decreases

c. lowers; increases

d. lowers; decreases

7. When the Fed raises the federal funds rate, consumption expenditure ____, investment ____, and aggregate demand ____.

a. increases; increases; increases

b. increases; decreases; changes but whether it increases or decreases is uncertain

c. decreases; increases; decreases

d.  decreases; decreases; decreases

8. If the Fed is concerned about a recession, the Fed will

a. buy government securities, lower the federal funds rate, and increase aggregate supply.

b. sell government securities, lower the federal funds rate, and increase aggregate demand.

c. sell government securities, raise the federal funds rate, and increase aggregate demand.

d. buy government securities, lower the federal funds rate, and increase aggregate demand.

Answer 1

2)

The Federal Reserve does not affect the federal fund rate directly. the Federal Reserve affects the Federal Fund rate indirectly.

To reduce the Federal Fund Rate, the Federal Reserve will use the expansionary monetary policy. The Open market operation will be used by the Federal Reserve.

The Fed will buy the securities from the open market thereby leading to rise in the reserve with banks. it would reduce the demand for the overnight fund, so here the Federal Fund rate will see the decline.

3)

The raising the Federal Fund rate implies that Fed is following the contractionary monetary policy. it would be conducted through the open market operation and other tools.

The rise in the Federal Fund rate, would reduce the money supply, so interest rate will rise here. the rise in the interest rate will cause the fall in the aggregate demand in the economy.

Thus the Real GDP and price level will decline in this economy.