Answer: The Fed should buy government securities. When the Fed buys government securities, the federal funds rate falls and banks' reserves increase. The increase in reserves increases the quantity of money and the interest rate falls. As a result, consumption expenditure, investment, and net exports increase, which increases aggregate demand. The increase in aggregate demand increases real GDP, which is the policy required when real GDP is less than potential GDP, that is, when the economy is in a recession.
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ReplyDeleteThe Fed should buy government securities. When the Fed buys government securities, the federal funds rate falls and banks' reserves increase. The increase in reserves increases the quantity of money and the interest rate falls. As a result, consumption expenditure, investment, and net exports increase, which increases aggregate demand. The increase in aggregate demand increases real GDP, which is the policy required when real GDP is less than potential GDP, that is, when the economy is in a recession.