Question

Suppose the Fed is worried because the unemployment rate is above the NRU. Due to this​ concern, the FOMC will discuss the direction of monetary policy at its next meeting. In this​ circumstance, one action the Fed could take would be to (increase decrease ) the discount rate. The​ Fed’s expectation is that this would make banks (less more) cautions about making​ loans; and​ thus, banks would make (more less) loans.    As a​ result, the money supply would ( increase decrease )​, and the nominal interest rate would ( rise fall) . As a​ result, Investment would (increase decrease) . Aggregate Demand would shift ( left right )​, and Real GDP would ( increase decrease )until full employment is restored. This action is referred to as (expansionary contractionary) monetary policy. Of the​ Fed's policy​ tools, changing the discount rate is A. the weakest tool. B. the weakest and least frequently used tool. C. the strongest and least frequently used tool. D. the most important and most frequently used tool.

Answer 1

Suppose the Fed is worried because the unemployment rate is above the NRU. Due to this​ concern, the FOMC will discuss the direction of monetary policy at its next meeting. In this​ circumstance, one action the Fed could take would be to decrease the discount rate. The​ Fed’s expectation is that this would make banks less cautions about making​ loans; and​ thus, banks would make more loans. As a​ result, the money supply would increase​, and the nominal interest rate would fall . As a​ result, Investment would increase . Aggregate Demand would shift right, and Real GDP would increase until full employment is restored. This action is referred to as expansionary monetary policy.

Option A Changing Discount rate is the weakest tool.

Suppose Fed wants to stimulate the economy by lowering the discount rate. If the Customers don't borrow from banks then there will be little reason that banks will borrow from Fed. Therefore lowering the discount rate would not be as effective in increasing the monetary base as open marketing operations.

Explanation

The natural rate of unemployment is related to two other important concepts: full employment and potential real GDP. The economy is considered to be at full employment when the actual unemployment rate is equal to the natural rate. When the economy is at full employment, real GDP is equal to potential real GDP. By contrast, when the economy is below full employment, the unemployment rate is greater than the natural unemployment rate and real GDP is less than potential. Finally, when the economy is above full employment, then the unemployment rate is less than the natural unemployment rate and real GDP is greater than potential.

Expansionary monetary policy (easy money policy) is
designed to counteract the effect of recession and return the economy to full employment; increases money supply; decreases interest rates and it tends to increase both investment and output.The Federal Reserve can increase the money supply by lowering the discount rate. Lowering the discount rate gives depository institutions a greater incentive to borrow, thereby increasing their reserves and lending activity. This increases aggregate demand , investment and employment in the economy.