To contract the economy with open market operation, the federal reserve will

Expert Solution

If the Fed's goal is contractionary, it sells Treasurys in order to pull money out of the system. Money gets tight, and interest rates drift upwards. Consumers pull back on their spending. Businesses trim their plans for growth, and the economy slows down.

The Fed will undertake the process when the economy is overheating and inflation is reaching the limit of its comfort zone. When the Fed sells bonds to the banks, it takes money out of the financial system, reducing the money supply.

This will cause interest rates to rise, discouraging individuals and businesses from borrowing and investing, while encouraging them to put their money in less productive investments such as interest-bearing savings accounts and certificates of deposit. This has the effect of slowing inflation and economic growth.

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