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In: Economics

If the Federal Reserve now suspects that inflation is rising at an unacceptable level, will they...

If the Federal Reserve now suspects that inflation is rising at an unacceptable level, will they seek to increase or decrease the money supply? What are at least two methods to accomplish this task?

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Expert Solution

Answer : 1) If money supply increase in the economy then the aggregate demand increase. This increase the inflation rate. If money supply decrease in the economy then the aggregate demand decrease. This decrease the inflation rate. Now if Federal Reserve realize that the rising inflation is unacceptable then Federal Reserve will decrease the money supply in the economy to control inflation.

2) Federal Reserve decrease the money supply by (i) selling bonds and securities through the Open Market Operation; and (ii) by increasing the federal fund rate.

If Fed sell bonds and securities then the money supply decrease in the economy. This decrease the aggregate demand. As a result, the inflation rate fall.

If Fed increase the fund rate then banks get less money to give loan. As a result, money supply decrease in the economy and interest rate increase. With higher interest rate people save more and spend less. With higher interest rate investment also decrease due to high borrowing cost. These decrease the aggregate demand which lead to fall the inflation rate.

Rahul Sunny answered 2 years ago
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