Question

The Fed’s $2.2 trillion fire hose The Fed threw a lot of money at the financial crisis in 2008 to unfreeze credit markets and encourage economic activity. As part of its effort to keep the interest rate low, the Fed purchased government bonds worth $300 billion during 2009. By October, the Fed held $770 billion in government securities, nearly double its pre-crisis total. Before the crisis, the Fed held mainly government securities, which it used to control the quantity of money in the economy. Now government securities make up just 35% of the Fed’s balance sheet. Source: CNN Money, October 9, 2009

 11. As the Fed purchased $300 billion of government securities, did the price of government securities fall or rise? Explain your answer.

 12. Explain how the Fed uses its government securities to control the nominal interest rate.

Answer 1

Ans 11)The OMO conducted by the Fed impacts the supply of money in the economy via the purchasing & selling of governmental securities

When the Fed buys governmental securities on the open market, it augments the reserves of common banks & enables them to raise their advances & investments;this subsequently raises the price of governmental securities & effectually lessens their interest rates; & lessens overall interest rates, stimulating corporate investments.

Ans 12)If the central bank buys securities issued by the government on the open market, it enhances commercial banks’ reserves & permits them to augment their loans/ investments; elevates the price of the securities &   efficaciously lessens their ROI; & lowers the overall interest rates, lowering the cost of borrowing for the corporates and thus, fostering business investments