Q 28 Explain how by lowering the federal Funds rate from 45

Q 28, Explain how by lowering the federal Funds rate from 4.5% to 4% the Federal Reserve can increase money supply in the economy and thereby GDP growth (Spoints)

Solution

The federal funds rate is the interest rate charged by the depository institutions each other to lend the reserve balances. The banks are intendend to keep a cerytain percenatge of their deposits as the reserves so if the federal funds are high the banks will be unable to borrow more money and if the other hand if the federal funds rate is low, that is an expansionary monetary policy the banks can borrow more money and will be able to lend out more money in to the economy. So a lower federal funds rate increase the money supply in the economy, the increase in the money supply will increase the aggregate demand in the economy. The AD curve will shift to the right and there by increases the real GDP in the country.