What can the central bank of Autarkia do to lower the rate which banks charge each other for overnight loans? How will this affect the economy if it is facing a downturn?
What will be an ideal response?
The central bank of Autarkia can increase the supply of reserves. This can be done by buying government bonds from private banks. Such a transaction is referred to as an open market operation. If the central bank buys government bonds from private banks, the supply curve of reserves will shift to the right. The demand for reserves will equal the supply of reserves at a lower federal funds rate. If the federal funds rate falls, the banks will be able to make more loans. The easy availability of loans will boost economic activity in the economy.
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