Homework 14 Monetary Policy: What Does The Fed Do To Impleme

Homework 14monetary Policy1 What Does The Fed Do To Implementexpansi

Homework #14 Monetary Policy 1. What does the Fed do to implement expansionary monetary policy? Draw the federal funds market with expansionary monetary policy 2. What does the Fed do to implement contractionary monetary policy? Draw the federal funds market with contractionary monetary policy 3. List and draw all the graphs showing all the ripple effects that happen in the economy when the Fed initiates expansionary monetary policy through the federal funds rate. 4. List and draw all the graphs showing all the ripple effects that happen in the economy when the Fed initiates contractionary monetary policy through the federal funds rate.

Paper For Above instruction

Introduction

Monetary policy is a critical tool used by the Federal Reserve (the Fed) to influence economic activity, stabilize prices, and promote maximum employment. It involves manipulating the money supply and interest rates, particularly the federal funds rate, to either stimulate or cool down the economy. This paper examines the mechanisms the Fed employs to implement expansionary and contractionary monetary policies, visualizes these through the federal funds market, and explores the ripple effects on the broader economy with supporting graphs.

Implementation of Expansionary Monetary Policy

Expansionary monetary policy aims to stimulate economic growth during periods of recession or economic slowdown. The primary tool the Fed uses is lowering the federal funds rate. To do this, the Fed engages in open market operations—buying securities, primarily government bonds, from banks and other financial institutions. This process increases banks' reserves, effectively decreasing the federal funds rate due to increased supply of reserves, which in turn encourages banks to lend more money to businesses and consumers.

In the federal funds market graph, the initial equilibrium is at a certain federal funds rate where the demand and supply of reserves intersect. Under expansionary policy, the Fed's actions shift the supply curve of reserves to the right, resulting in a lower equilibrium federal funds rate. This decline in the rate reduces the cost of borrowing, leading to an expansion of credit, increased investment, and higher consumer spending.

Graph of Expansionary Monetary Policy in the Federal Funds Market

[Insert a graph showing the federal funds market with the supply curve shifting right, lowering the equilibrium rate, labeled appropriately.]

Implementation of Contractionary Monetary Policy

Conversely, contractionary monetary policy seeks to curb inflation and prevent an overheated economy. The Fed raises the federal funds rate by selling government securities in open market operations, which reduces banks' reserves. This contraction decreases the supply of reserves, shifting the supply curve to the left in the federal funds market, leading to an increase in the equilibrium federal funds rate.

An increasing federal funds rate makes borrowing more expensive for banks, which translates into higher interest rates for consumers and businesses. Consequently, borrowing, spending, and investment decline, helping to temper inflationary pressures.

Graph of Contractionary Monetary Policy in the Federal Funds Market

[Insert a graph showing the supply curve shifting left, raising the equilibrium rate, labeled appropriately.]

Ripple Effects of Expansionary Monetary Policy

Implementing expansionary policy has several ripple effects throughout the economy. First, lower interest rates decrease the cost of borrowing, leading to increased household consumption and business investments. This boosts aggregate demand, resulting in higher output and employment levels in the short term.

Furthermore, increased borrowing raises the demand for loanable funds, which can lead to a subsequent rise in asset prices, including stocks and real estate. Higher demand and spending can cause inflationary pressures if sustained. The increased economic activity can also affect the foreign exchange market, leading to a depreciation of the national currency, which can boost exports.

A series of interconnected graphs demonstrates these ripple effects:

- Aggregate demand and supply model shift outward, leading to higher output and price levels.

- Investment demand curve shifts rightward in the loanable funds market.

- Asset prices increase, represented by upward shifts in stock and real estate graphs.

- Depreciation of the currency enhances exports, depicted in the exchange rate graph.

Ripple Effects of Contractionary Monetary Policy

Conversely, contractionary policy induces a series of macroeconomic adjustments. Higher interest rates discourage borrowing and spending by consumers and firms, resulting in decreased aggregate demand. This often leads to lower output and employment in the short run.

The reduction in borrowing suppresses investment activities, shifting the investment demand curve to the left. Asset prices, including stocks and real estate, tend to fall due to diminished demand. Additionally, higher interest rates can lead to currency appreciation, making exports less competitive and further dampening economic growth.

The interconnected graphs revealing these ripple effects include:

- A leftward shift of the aggregate demand curve.

- Investment demand curve shifting leftward.

- A decrease in asset prices, represented graphically.

- Currency appreciation, showing through exchange rate movements.

Conclusion

The Federal Reserve's implementation of expansionary and contractionary monetary policies profoundly influences the economy through adjustments in the federal funds rate and reserves. These policy actions initiate a cascade of ripple effects across various sectors—consumption, investment, asset markets, and exchange rates—ultimately shaping economic growth, inflation, and employment. Visual representations through graphs highlight how shifts in the federal funds market translate into broader macroeconomic outcomes, emphasizing the interconnectedness of financial markets and real economic activity.

References

1. Mishkin, F. S. (2019). The Economics of Money, Banking, and Financial Markets (12th ed.). Pearson.

2. Bernanke, B. S. (2007). Inflation Expectations and Monetary Policy. Conference Series.

3. Blanchard, O., & Johnson, D. R. (2013). Macroeconomics (6th ed.). Pearson.

4. Federal Reserve Bank of St. Louis. (2022). How Does the Fed Implement Monetary Policy? Retrieved from https://www.stlouisfed.org

5. Mishkin, F. S., & Eakins, S. G. (2015). Financial Markets and Institutions (8th ed.). Pearson.

6. Taylor, J. B. (1993). Discretion versus policy rules in practice. Carnegie-Rochester Conference Series on Public Policy, 39, 195-214.

7. Woodford, M. (2003). Interest and Prices: Foundations of a Theory of Monetary Policy. Princeton University Press.

8. Romer, D. (2018). Advanced Macroeconomics (5th ed.). McGraw-Hill Education.

9. Schmidt-Hebbel, K., & Tapia, R. (2005). Inflation targeting and monetary policy: An overview of the monetary policy from 1990. International Monetary Fund.

10. Federal Reserve. (2023). Monetary Policy Report. Board of Governors of the Federal Reserve System.