Final answer:
To keep interest rates stable in response to an increased demand for money, the Federal Reserve would increase the supply of money. This is achieved through monetary policy tools such as lowering the discount rate. A steady increase in the money supply is preferred to match the economy's growth and prevent instability.
Step-by-step explanation:
If the goal of monetary policy is to keep interest rates stable, the Federal Reserve's response to increases in the demand for money would be to increase the supply of money. This action helps to prevent interest rates from rising due to increased demand. The Federal Reserve regulates the supply of money in the economy and can utilize various monetary policy tools to achieve economic stability. Increasing the supply of money can be done by lowering the discount rate, which encourages more borrowing by banks and effectively increases the money supply in the broader economy.
Fluctuations in the business cycle influence the adoption of fiscal policies that complement the monetary policy measures. The Federal Reserve aims to protect both the banking system and the public's deposits by managing the money in circulation. Through measures such as altering reserve requirements and adjusting the discount rate, they can counteract undesired economic disturbances.
According to economists like Milton Friedman, the best approach for the central bank is to increase the money supply at a steady pace to match the growth of the real economy. This prevents the money supply from becoming a source of economic instability and limits the central bank's discretion in policy-making, thereby promoting a predictable economic environment.