Question

• The change in money supply affects the economic agents. Suppose the Federal Reserve increases the money supply to boost aggregate demand during recessionary pressure. How does the increase in money supply affect consumer spending and investment? How does it affect the firm or organization you work for? How do the Federal Reserve policies affect us as individuals (households)?

Answer 1

It is given that the Federal Reserve increases the money supply to boost aggregate demand during recessionary pressure. For a given level of income, an increase in the money supply raises the real money balances in the hands of the people. So, people will use the extra money for speculative purpose. As a result, the demand for bonds will rise. This will increase the price of bonds while their yield (interest rate) will decline.

A decline in the interest rate will stimulate investment demand in the economy, as businesses will find it cheaper to borrow for investment in plants and machinery. An increase in the investment demand will raise the level of income in the economy. Increase in the level of income will raise consumption demand because of which the income level will increase through the multiplier effect.

So, an expansionary monetary policy will raise the share of investment in the GDP. In addition to this, the expansionary monetary policy will also raise the level of consumption by the households in the economy.