Question

1. Please fill in the table below. Show how expansionary activities conducted by the Federal Reserve impact credit availability, the money supply, interest rates, and security prices. Do the same for contractionary activities (↑, ↓ or NC)  

Expansionary	↑, ↓ or NC	Contractionary	↑, ↓ or NC
Credit Availability		Credit Availability
Money Supply		Money Supply
Interest Rates		Interest Rates
Security Prices		Security Prices

Answer 1

Expansionary	↑, ↓ or NC	Contractionary	↑, ↓ or NC
Credit Availability	↑	Credit Availability	↓
Money Supply	↑	Money Supply	↓
Interest Rates	↓	Interest Rates	↑
Security Prices	↑	Security Prices	↓

Expansionary Activities are conducted by the Federal Reserve when the economy is sluggish to seek Economic Growth.

Expansionary activities of the Federal Reserve include open market purchase of securities,decreasing the interest rate and reducing the reserve requirement.

Keeping everything else constant, when the Federal Reserve purchases securities in the open market , the reserve account of the bank increases.Hence the banks have excess money which they can lend, thus increasing the credit availability in the economy, and thereby increasing the money supply.

When Federal Reserve lowers the discount rate, it generally results in lowering of interest rates in the economy.So when interest rates are less, Business's will borrow more which will result in the increase of the money supply in the economy.

And when the Fed lowers it's reserve requirement (Keeping everything else constant), the reserve of the banks increases.So the bank's are in a position to lend more which again results in increase in the credit availability in the economy which in turn increases the money supply in the economy.

So with lower interest rates, greater availability of credit and the increase in the money supply in the economy, the Aggregate demand increases. This results into higher level of spending and high consumer confidence.

Hence the Security Prices rises as these expansionary activities by the Fed leads to increase in Sales and earnings of corporations.

Contractionary Activities are conducted by the Federal Reserve when the economy is growing too fast and the inflation is moving significantly high. To slow the economic growth and control the inflation in the economy, the Federal Reserve will increase the interest rates to make borrowing more expensive.As business's borrow less(because of high interest rates),they expand less and hire less workers which in turn reduces the Aggregate Demand, which in turn results in fall in the security prices.Also because of the less borrowing the money supply in the economy also reduces.

The Fed also uses open market operation like selling Treasury Notes to it's member banks.The banks pays Fed for the Treasury Notes, which results in less money available with the bank to lend.Hence the Credit availability decreases which results in decrease in the money supply in the economy.

Since the Contractionary activities of the Fed reduces the Aggregate Demand in the economy, prices fall which puts an end to inflation. But contractionary policy should be exercised with extreme care as it can sometimes lead an economy into recession.