Question

1) Explain in detail how open market operations have a direct and immediate impact on the federal funds rate and the money supply.

2) What are some of advantages and disadvantages of monetary policy in comparison to fiscal policy?

3) Explain how a strong economy will impact interest rates in the loan market?

Answer 1

1. The Federal Reserve is buying and selling the United States. Treasury securities on the open market to control the money supply that is on deposit in U.S. banks and is therefore free to lend to businesses and consumers. This buys Treasury securities in order to increase the money supply and sell them to reduce the money supply.
The Federal Reserve will achieve the target federal funds rate it has set by using this open-market purchasing system. It calls its open market operations to this method.

The price of federal funds is the amount of interest charged by banks for overnight loans. The constant flow of vast sums of money allows banks to keep their cash reserves high enough to satisfy customer demands while making use of excess cash. Furthermore, the federal funds rate is a benchmark for other rates, affecting everything from savings deposit rates to home mortgage rates and interest on credit cards. The Federal Reserve is setting a target federal funds rate on an even keel for the U.S. economy in an effort to prevent the ill effects of unchecked market inflation or deflation.

2. In an expansionary monetary policy, where banks are reducing interest rates on loans and mortgages, it would allow more business owners to expand their projects as they would have more available funds to invest at competitive interest rates. However, commodity prices would also be reduced, and buyers would have more opportunities to buy more products. Businesses would therefore earn more revenue and customers would be able to afford basic goods, products and even land.

A monetary policy can be used by the Federal Reserve to produce and print more money, allowing them to buy government bonds from banks, resulting in increased monetary base and cash reserves in banks. This also means lower interest rates and potentially more money to lend their lenders to financial institutions.

Because monetary policy could lower interest rates, it would also imply that lower payments will allow homeowners to mortgage their properties, allowing homeowners to spend more money on other important things. It would also ensure customers would settle their monthly payments on a regular basis — a win - win situation for lenders, retailers and real estate investors

Economists who criticize the Federal Reserve for implementing monetary policy claim that not all customers would have the courage to spend and benefit from low interest rates during recessions, making it a drawback.

Expansionary monetary policy advocates note that the export sector will struggle even if banks lower interest rates for customers to spend more money during a global recession. If that is the case, export losses would be more than they would gain from their sales by commercial organizations.

3. Consumers ' interest on their mortgages will be increased. When interest rates rise, the borrowing price of investments such as a vehicle, a house, and college tuition rises. However, existing debt linked to a floating index, such as some home equity loans, will also increase cost. Sadly for individuals, since interest costs are rising and people are putting more money into servicing their mortgages, they have less money available for school and retirement savings or saving.

Corporations are also going to pay more for their loans. Businesses loaded up on cheap debt while interest rates were low. Now with interest rates rising, the price of that debt may become more costly on their balance sheets. They don't have that cash if companies have to pay more for their debt to pay more employees and purchase more stock to expand. This could funnel the higher interest spending into the labor market and slow the economy down.

There are lower returns on bonds and bank accounts. If bond yields and bank interest rates are lower, they compete more successfully with stocks for the assets of investors. While this is good for low-risk savers, if money leaves the stock market for these higher returns, this could result in decreases in stock prices that could affect your401(k) and other investments.