Question

If the Federal Reserve decided to increase the money supply by engaging in open market bond purchases from the non-bank public, explain what will happen to the equilibrium interest rate in the U.S. (in your description mention or show with a graph the change in the supply curve for loanable funds and the change in its intersection with the demand curve for loanable funds.

    

Answer 1

If the Federal Reserve decides to increase the money supply by engaging into the open market Bond purchase from non-bank public, it would be considered that Federal Bank is trying to provide liquidity into the economy by infusing more money into the market and hence it would be leading to increase in the money supply and it will also lead to increase in the interest rate in the United States because increase in the interest rates will be done in order to deal with the increasing money supply in the economy.

There will be a moderate increase in interest rates due to increasing demand in the economy and it will be leading to increase in the demand for the loanable funds and it would mean that the supply of the loanable funds will be lower and the demand of the loanable funds will be increasing hence the overall demand curve will be shifting to the right, as it will be representative of the demand which has increased due to infusion of liquidaty by the Federal Reserve into the market by purchasing of the non Bank bonds and it will be taken as a moderately bullish scenario in which the Federal Reserve is trying to stimulate the economy by infusion of liquidity and it will be leading to increase in demand in the economy which will be leading to increase in the monetary supply in the economy and hence it can be said that the overall loanable funds demand will also increase and it will be increasing in order to absorb the supply of the loanable funds and the demand of the loanable funds will be increasing and the demand curve will be shifting to the right.