Steps the Fed might have taken to achieve this effect:
- Open market operations: The Fed buys government securities in the open market. This injects money into the financial system and increases the money supply.
- Quantitative easing: The Fed electronically purchases government securities and other assets directly from banks. This also increases the money supply.
- Lowering reserve requirements: The Fed reduces the amount of money that banks are required to hold in reserve. This allows banks to lend out more money, which increases the money supply.
The graph shows the supply and demand curves for money. The supply curve (S) is upward sloping, meaning that the quantity of money supplied by banks increases as the interest rate rises. The demand curve (D) is downward sloping, meaning that the quantity of money demanded by households and businesses decreases as the interest rate rises.
The equilibrium point is the point where the supply and demand curves intersect. At this point, the quantity of money supplied equals the quantity of money demanded.
Monetary expansion is a policy tool used by the Federal Reserve to increase the money supply. This can be done through a variety of ways, such as open market operations, quantitative easing, and lowering reserve requirements.
The graph shows that when the Fed conducts monetary expansion, the supply curve (S) shifts to the right (from S to S1). This increases the quantity of money supplied at each interest rate.
As a result of the increase in the money supply, the equilibrium point moves from E to E1. This means that the interest rate falls (from iA to iB) and the quantity of money increases (from Q0 to Q1).
Why the Fed might have taken these steps:
- To stimulate economic growth: When the economy is weak, the Fed may use monetary expansion to increase borrowing and investment. This can help to boost economic activity and create jobs.
- To prevent deflation: Deflation is a sustained decline in the general price level. This can be harmful to the economy because it can lead to businesses and consumers delaying spending decisions. The Fed may use monetary expansion to prevent deflation by increasing the money supply and putting upward pressure on prices.
- To weaken the dollar: A weaker dollar can make exports more competitive and boost net exports. This can be beneficial for the economy if the trade deficit is large.