The economy has been sluggish in recent months with slow economic growth. Explain the actions and policies the Federal Reserve could use to improve the economy.

Question

A. The Federal Reserve stops purchasing treasuries and securities, and then issues new reverse repurchase agreements. The short-term profits and decrease in the money supply cause a decrease in interest rates and increased lending.
B. The Federal Reserve purchases treasuries and securities and also issues new repurchase agreements. The increase in the money supply and decrease in interest rates result in more lending and risk.\
C. The Federal Reserve sells treasuries back to banks and issues new revers repurchase agreements. The decrease in the money supply increases interest rates, which increases lending.
D. The Federal Reserve cuts the purchases of treasuries and securities in half, and also issues half of the expected number of new repurchase agreements. The increase in the money supply increases interest rats and inflation, which spurs economic growth.

Answer 1

To improve a sluggish economy, the Federal Reserve (the Fed) typically implements measures that aim to stimulate economic activity by increasing the money supply and lowering interest rates, which can encourage borrowing and spending.

Let’s evaluate the options provided:

A. The Federal Reserve stops purchasing treasuries and securities, and then issues new reverse repurchase agreements. The short-term profits and decrease in the money supply cause a decrease in interest rates and increased lending.

• This option is flawed because stopping the purchase of treasuries and securities would typically lead to a contraction of the money supply, which could actually increase interest rates instead of decreasing them. Reverse repurchase agreements would likely have a similar contractionary effect. This wouldn't stimulate the economy effectively.

B. The Federal Reserve purchases treasuries and securities and also issues new repurchase agreements. The increase in the money supply and decrease in interest rates result in more lending and risk.

• This scenario outlines a common expansionary policy. By purchasing treasuries and securities, the Fed increases the money supply, which tends to lower interest rates. Lower interest rates can encourage borrowing and investment, which can help stimulate economic growth. This is a viable action for the Fed to use in a sluggish economy.

C. The Federal Reserve sells treasuries back to banks and issues new reverse repurchase agreements. The decrease in the money supply increases interest rates, which increases lending.

• This option is incorrect because selling treasuries and issuing reverse repurchase agreements would lead to an increase in interest rates due to a decrease in the money supply, which generally would not encourage lending or economic growth. This approach would likely be contractionary rather than stimulative.

D. The Federal Reserve cuts the purchases of treasuries and securities in half and also issues half of the expected number of new repurchase agreements. The increase in the money supply increases interest rates and inflation, which spurs economic growth.

• This option is contradictory. Cutting purchases of securities would typically lead to a decrease in the money supply, potentially increasing interest rates. While inflation can sometimes stimulate economic growth, in this scenario, a reduction in Fed activity would likely not lead to the desired effect of stimulating the economy.

From the evaluation, Option B is the most appropriate and reflective of actions the Federal Reserve could take to stimulate a sluggish economy. It describes a clear expansionary monetary policy that aims to increase the money supply and lower interest rates, which can encourage more lending and thereby stimulate economic growth.