33. Suppose the economy is in a recession, and the Federal Reserve will use open market operations to stimulate economy. Explain what they will do and briefly explain how this action is expected to stimulate the economy.
Answer : Open market operation is a monetary policy tool. When the economy is in recession then Federal Reserve purchase bonds and securities through the open market operation. As a result, the money supply increase in the economy. Higher money supply decrease the interest rate which decrease the borrowing cost. As a result, investment increase. Due to higher money supply people get more money on their hand to spend and with lower interest rate people spend more and save less. As a result, consumption increase. Due to increase in consumption and investment the aggregate demand increase which shift the AD (Aggregate Demand) curve to rightward. As a result, recession eliminate. Thus Federal Reserve use the open market operation to stimulate the economy in recession.
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