Question

• Discuss how changes in the Federal Reserve’s monetary policy affect at least 1 of the 4 components of GDP (consumption, investment, government spending, net exports).
• Have the Federal Reserve’s countercyclical monetary policies been effective in moderating business cycle swings? Justify your response.

Answer 1

During every business cycle be it recessiom or depression or anyother, the Federal Reserve has to deal with it by either increasing or decreasing money supply in order to maintain stability in the economy with respect to inflation , interest rates , money supply. This are done by making some changes in the monetary policy. Every policy is undertaken to counter attack the economic issues. Federal reserve undertakes such policies by various methods among which are Open Market Operations, Fed Rate, changes in reserve requirements. Taking the case of OMO (open market operations) , here government bonds are bought and sold in the market, here bonds are solding in the market and in return money from market in taken thereby reducing money supply and when bonds are purchased by Federal Reserve, it means money is injected by the Federal Reserve in return for purchasing bonds. This way money is injected and taken out from the economy. So when money flow increases, this money goes in the hands of people in some way or other, people has more disposible income than before therefore they are likely to consume more than before leading to increase in demand for goods and services and ultimately increase in conaumption, which in return leada to growth in the economy being a parameter to calculate growth in an economy.

Majorly Federal Reserve's monetary policy and tool used are focused to counter the business cycle of the economy and is successful however along with it proper fiscal policy must be backed up by the government to boost its effectiveness. By countercyclic it means during any phase of economic cycle say recessiom federal reserve needs to act in a manner to counter this cycle of economy in order to bring stability. Most of the time Federal Reserve comes out with measures as mentioned above and thus helps to boost economy, reduce unemployment, stabilize prices and interest rates.