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Chapter 16: Q.18 - Problems (page 369)

Consider the two panels of Figure 16-2. Suppose that instructions in the latest FOMC Directive call for a monetary policy action aimed at pushing down the rate of interest prevailing in the economy. Use the appropriate panel of the figure to assist in explaining whether officials at the Federal Reserve Bank of New York's Trading Desk should buy or sell existing bonds.

Short Answer

Expert verified

The desk should buy securities to decrease the interest rate in economy.

Step by step solution

01

FOMC Concept

Federal Open Market Operations means buying & selling of government securities in open market. It is used as a monetary (quantitative) credit control tools.

Central bank buys securities (giving commercial banks & public cash) - to increase money supply, liquidity in economy.
Central bank sells securities (getting cash from commercial banks & public) - to decrease money supply, liquidity in economy

02

Interest Concept Explanation

Interest rate is the price of money, so it is directly related to money supply.

More money supply implies low interest rates, & less money supply implies high interest rate in the economy.

So, when central bank buys securities & increases money supply - it leads to lower interest rates in the economy.

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Most popular questions from this chapter

Assume that the following conditions exist :

a. All banks are fully loaned up - there are no excess reserves, and desired excess reserves are always zero.

b. The money multiplier is $3$ .

c. The planned investment schedule is such that at a $6$ percent rate of interest, the investment is $\(1200$ billion; at 5 percent, investment is $\) 1225$ billion

d. The investment multiplier is $3$ .

e. The initial equilibrium level of real GDP is $\(18$ trillion.

f. The equilibrium rate of interest is $6$ percent.

Now the Fed engages in expansionary monetary policy. It buys $\) 1$ billion worth of bonds, which increases the money supply, which in turn lowers the market rate of interest by $1$ percentage point. Determine how much money supply must have increased, and then trace out the numerical consequences of the associated reduction in interest rates on all the other variables mentioned.

Assume that the following conditions exist :

a. All banks are fully loaned up - there are no excess reserves, and desired excess reserves are always zero.

b. The money multiplier is $4$ .

c. The planned investment schedule is such that at a $4$ percent rate of interest, investment is $\(1400$ billion. At $5$ percent, investment is $\) 1380$ billion.

d. The investment multiplier is $5$ .

e. The initial equilibrium level of real GDP is $\(19$ trillion.

f. The equilibrium rate of interest is $4$ percent.

Now the Fed engages in contractionary monetary policy. It sells $\) 2$ billion worth of bonds, which reduces the money supply, which in turn raises the market rate of interest by 1 percentage point. Determine how much the money supply must have decreased, and then trace out numerical consequences of the associated increase in interest rates on all other variables mentioned.

Consider figure 16.3, Discuss a policy action that trading desk at the federal reserve bank of New York could undertake in order to generate the decrease in aggregate demand displayed in this figure

What do you think might be lost-and by whom - if the Fed were to follow an easily understood rule as a guide for conducting monetary policy? Explain.

Why do you suppose that corporate cash holdings have decreased slightly since 2015?

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