Explain how the Fed's response to inflation works its way through the economy to ultimately affecting real GDP and the price level
What will be an ideal response?
When the Fed is concerned with inflation, the Fed raises the federal funds rate target. To then boost the federal funds rate up to the new target, the Fed conducts open market operations that sell government securities. This sale requires that banks and other purchasers pay for their purchases by using banks' reserves, which decreases the amount of reserves available for banks. The decrease in reserves raises the federal funds rate. It also decreases the quantity of money. The decrease in the quantity of money and bank loans decreases the supply of loanable funds so the real interest rate rises. The higher real interest rate leads to a decrease in the demand for investment and other interest-sensitive sectors of the economy. These decreases mean that aggregate demand decreases so that the AD curve shifts leftward. Following the original decrease in aggregate demand, a multiplier process begins which decreases aggregate demand even further, so that there is a further leftward shift of the AD curve. As a result of the decrease in aggregate demand, the price level falls and real GDP decreases.
You might also like to view...
Most economists would agree that "saving jobs" is a valid reason for restricting trade
Indicate whether the statement is true or false
Compared to a proprietorship, a disadvantage of a partnership is
A) that profits are taxed twice. B) that it is harder to keep the firm going after the death of an owner. C) unlimited liability. D) that potential liability to each partner is greater.
As a result of moving more decision making from the center toward the periphery of the organization, typically
a. the flow of relevant information to the decision maker should be enhanced b. the flow of relevant information from the decision maker should be enhanced c. the incentives to make good decisions can be weakened d. the reporting of information that is required to make the decision can be relaxed
Price controls are usually enacted in response to
a. popular opinion. b. governmental studies. c. scholarly research on the effects of high prices. d. laws enacted in other countries. e. All of the above are correct.