Answer: When the Fed is concerned with recession, the Fed lowers the federal funds rate target. To then lower the federal funds rate to the new target, the Fed conducts open market operations that buy government securities. The Fed pays for its purchases by increasing banks' reserves. The increase in reserves lowers the federal funds rate. It also increases the quantity of money. The increase in the quantity of money shifts the supply of money curve rightward and the interest rate falls. The lower interest rate leads to an increase in the demand for investment and other interest-sensitive sectors of the economy. These increases mean that aggregate demand increases so that the AD curve shifts rightward. Following the original increase in aggregate demand, a multiplier process begins which increases aggregate demand even further, so that there is a further rightward shift of the AD curve. As a result of the increase in aggregate demand, the price level rises and real GDP increases.
Answer:
ReplyDeleteWhen the Fed is concerned with recession, the Fed lowers the federal funds rate target. To then lower the federal funds rate to the new target, the Fed conducts open market operations that buy government securities. The Fed pays for its purchases by increasing banks' reserves. The increase in reserves lowers the federal funds rate. It also increases the quantity of money. The increase in the quantity of money shifts the supply of money curve rightward and the interest rate falls. The lower interest rate leads to an increase in the demand for investment and other interest-sensitive sectors of the economy. These increases mean that aggregate demand increases so that the AD curve shifts rightward. Following the original increase in aggregate demand, a multiplier process begins which increases aggregate demand even further, so that there is a further rightward shift of the AD curve. As a result of the increase in aggregate demand, the price level rises and real GDP increases.