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Monetary and Fiscal Policy and Policy Debate

1. Suppose you read in the newspaper that last week the Fed conducted open market purchases, and that on Tuesday of last week it lowered the discount rate. What would you say the Fed was up to? Describe the most likely economic condition of the economy.

2. What three tools can the Fed can use to change the money supply? Which tool is used most frequently? What are two limitations on the money expansion process?

3. Explain why incorporating money into our macroeconomic framework moderates the effects of fiscal policy. That is, how does the existence of the supply and demand for money moderate the effects of increased government spending?

Solution Preview

The Fed's three tools are the manipulation of the discount rate, the required reserve rate, and open market operations. When the Fed purchases securities, it increases the money supply. Lowering the discount rate or the reserve rate would have the same effect. So, for #1, the Fed is obviously increasing the money supply. It would do this to help the economy grow, so most likely the economy is experiencing a recession, or is giving indictions that it might enter one if steps are not taken soon.

The most powerful tool available is the reserve requirement. The reserve requirement is the percentage of money ...

Solution Summary

The Federal Reserve's tools for economic management and their limitations. How fiscal policy is limited by the supply and demand for money.