Question

Suppose that the Fed makes a $100 billion open-market sale of Treasury bonds, and the money multiplier is 6. Which of the following impacts are most likely to result?
a. The money supply shifts inward, and the equilibrium interest rate rises in the money market.
b. The money supply shifts outward, and the equilibrium interest rate falls in the money market.
c. Investment declines, causing the aggregate demand curve to shift leftward, reducing equilibrium real GDP and thus slowing the economy.
d. Both answers a. and c. are correct.
e. Both answers b. and c. above are correct

If the Fed reduces the discount rate, which of the following are most likely to result?
a. The money supply curve shifts rightward, and the equilibrium interest rate falls in the money
market.
b. Investment spending declines, causing the aggregate demand curve to shift leftward, reducing equilibrium real GDP and thus slowing the economy.
c. Investment spending rises, causing the aggregate demand curve to shift rightward, increasing equilibrium real GDP and thus accelerating the economy.
d. Both answers a. and b. above are correct.
e. Both answers a. and c. above are correct

Answer 1

- d is correct

Open market sale of bonds in exchange for money reduces the money supply in the market. This shifts money supply inward and the interest rate rises.

Increase in interest rate increases the cost of borrowing which further reduces investment spending. This decrease in spending leads to leftward shift in aggregate demand, decreasing real gdp and slowing the economy.

- e is correct

Reduction in discount rate increases the money supply as cost of borrowing to banks reduces. This shifts money supply rightward and interest rate falls. Decrease in interest rate leads to increase in investment spending which further leads to increase in aggregate demand.