Suppose the Fed buys government bonds. (a) Does the open market operation described above increase the...

Suppose the Fed buys government bonds.

(a) Does the open market operation described above increase the price level? Defend

your answer.

(b) Does the open market operation described above redistribute resources between

creditors and debtors? Defend your answer.

Solutions

Expert Solution

The open market purchasis raise bond pricesand open market sales lower the bond prices.

When the federal reserve buys bonds through open market operation the fed is increasing the demand for bonds.If an individual buys bonds, it is not enough to move prices up in the market.

The result of the fed's open market purchases is an increase in demand that is large enough to raise bond prices.Existing bondholders wanted those bonds for various reasons, so the fed must offer them higher prices to convince them to sell.

b) By using the open market purchases system, the federal reserve can produce the target federal funds rate it has set by providing or eals taking liquidity to commercial banks by buying or selling government bonds with them. The objective of OMOs is go manipulate the short term interest rate and the supply of base money in an economy

Buying securities adds money to the system, making loans easier to obtain and interest rate decline.

Rahul Sunny answered 1 year ago

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