Economic policies and their effectiveness

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Monetary policies change the level of the money supply in a country. Expansionary monetary policy expands (increases) the supply of money, whereas contractionary monetary policy contracts (decreases) the supply of a country's currency. Monetary policy can be used to control inflation or improve the economy. Contractionary monetary policy has the effect of reducing inflation by reducing upward pressure on price levels. Expansionary monetary policy spurs economic growth lowering the interest rates, which lowers the cost of financing capital projects. So expansionary policy will also help households who are in debt, by lowering the interest rate they pay. It also encourages them to buy because often purchases are made on credit. Business benefits from the increased capital investment as well. GDP increases as demand increases. Unemployment drops. The federal budget will often show a surplus as the tax base increases.

In addition monetary policy affects interest rates, people make or lose money from interest rate fluctuations, and therefore the markets are constantly trying to forecast the next monetary policy adjustment. This interaction?policymakers trying to understand and interpret markets, and markets trying to predict what policymakers will do?makes the task of designing an optimal monetary policy rule a very, very difficult problem. This is because even now the economy begins to respond before the Fed had even taken action. The more predictable the Fed's rule, the more the economy would be affected by this type of antipation.

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 ...