Question

How does the Fed use changes in its balance sheet to conduct monetary policy?

A) By adjusting interest rates.
B) By influencing the money supply.
C) By regulating fiscal policy.
D) By controlling exchange rates.

Answer 1

The Fed uses changes in its balance sheet to conduct monetary policy by influencing the money supply and adjusting interest rates.

Step-by-step explanation:

The Federal Reserve uses changes in its balance sheet to conduct monetary policy primarily by:

1. Influencing the money supply: The Fed can increase or decrease the money supply by conducting open market operations, which involve buying or selling government bonds. When the Fed buys bonds, it injects money into the economy, increasing the money supply. When it sells bonds, it absorbs money from the economy, decreasing the money supply.
2. Adjusting interest rates: The Fed can also influence interest rates by adjusting the federal funds rate. When the Fed lowers the federal funds rate, it becomes cheaper for banks to borrow money, which encourages lending and stimulates economic activity. Conversely, when the Fed raises the federal funds rate, it becomes more expensive for banks to borrow money, which discourages lending and slows down economic activity.