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Federal Reserve Policies

New data available to the Federal Reserve shows that the unemployment rate has risen to 7%. The Federal Funds rate is currently 5%.

a. The Federal Reserve is considering whether to raise the Federal Funds rate to 6%, lower it to 4%, or leave it at 5%. What do you suggest? Carefully Explain.

b. Based on your answer to part a above would you suggest the Federal Reserve, buy bonds, sell bonds, not buy or sell bonds? Carefully Explain.

c. Using the AD/AS model what do you predict will happen to the level of Real GDP and the Price level in the U.S. in the Short-Run and Long-Run? Carefully Explain (a graph would help).

Solution Preview

a. Because unemployment is rising, the Fed needs to pursue an expansionary monetary policy. This requires a lower interest rate. When the Fed lowers interest rates it 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 ...