Question

1. Explain how the Federal Reserve’s lowering of interest rates affects the following variables in the short run: household consumption, business investment, real GDP, and the price level. Insert or attach a well-labeled Aggregate Demand/Aggregate Supply graph that would illustrate the effect of a cut in interest rates.
2. What is one macroeconomic problem that could cause the Federal Reserve to become aggressive in raising interest rates? Explain. Describe one issue that could cause the Fed to lower rates?
3. Define the “federal funds rate”? briefly describe the pattern of the federal funds rate in the last ten years: At what level did Federal Reserve officials vote to leave their benchmark interest rate at last month’s policy meeting?   explain why the federal funds rate is important for the conduct of monetary policy?

Answer 1

Every economy faces business cycle inflation deflation etc . To control such business cycles every country Central Bank has some tools to control them. They are open market operations repo rate reverse repo rate CRR ratio and monetary policy. With the help of monetary policy every country Central Bank lowers and increases the interest rate based upon the existence of inflation or deflation. If inflation is rising in the economy Central Bank rises the interest rate to reduce the money in circulation and discourage consumption. In case of deflation to control it central bank pumps funds into economy at lower interest rate to increase consumption and investment.

if inflation is riding high in the economy the fed would raise interest rates to control money supply. Inflation a situation in which the value of money gets Eroded due to a situation in which more money chases lesser number of goods thereby increasing the money claimed by each product thereby raising the price.

when public consumption is low due to depression and decreased investment in economy the fed would lower the interest rates to encourage consumption and investment in the economy and this helps the economy upto some extent.

the federal funds rate is the rate at which banks and depository institutions lend money to each other from the reserve balances on overnight basis. As per the requirements of law every bank is required to park some funds ora non interest account with fed to ensure that they will have enough money to cover withdrawal payment and other obligations.

The federal funds rate is the determinant of monetary policy that whether it would be expansionary or contractionary .a higher interest rate would be indicator of contractionary monetary policy and the lower interest rate would be an indication of expansionary monetary policy. Hence it is an important determinant for monetary policy