Question

First, discuss demand-side economics and supply-side economics as methods of stimulating a weak economy. Second, how can the tools of monetary policy be used as a means of stimulating the economy? (review two (2) tools of monetary policy).

Answer 1

This was supply-side economics, also known as Reaganomics. Supply-siders believe that economic activity is motivated by after-tax returns to that activity. Thus, people are attracted to jobs that pay well, and businesses are attracted to industries with high profits. Additionally, tax cuts increase economic activity.

Tools of monetary policy

Open Market Operations

The Fed's most commonly used tool is open market operations. That's when it buys Treasury notes from its member banks.1 Where does it get the funds to do so? The Fed simply creates the credit out of thin air. That's what people mean when they say the Fed is printing money.

By replacing the banks' Treasury notes with credit, the Fed gives them more money to lend.2 To lend out the excess cash, banks reduce lending rates. That makes loans for autos, school, and homes less expensive. They also reduce credit card interest rates. All of this extra credit boosts consumer spending..

The discount rate is the interest rate Reserve Banks charge commercial banks for short-term loans. Federal Reserve lending at the discount rate complements open market operations in achieving the target federal funds rate and serves as a backup source of liquidity for commercial banks. Lowering the discount rate is expansionary because the discount rate influences other interest rates. Lower rates encourage lending and spending by consumers and businesses. Likewise, raising the discount rate is contractionary because the discount rate influences other interest rates. Higher rates discourage lending and spending by consumers and businesses. Discount rate changes are made by Reserve Banks and the Board of Governors.