Final answer:
In response to a recession, the Federal Reserve should decrease interest rates to stimulate borrowing and spending, which aligns with expansionary monetary policy. This approach is aimed at increasing aggregate demand to help revive the economy. Option B is correct.
Step-by-step explanation:
During a recession and declining inflation, the Federal Reserve is likely to take actions that will stimulate the economy. According to Keynesian economic principles, the appropriate monetary policy in such a scenario is expansionary monetary policy. This type of policy involves the central bank increasing the supply of money and loanable funds, leading to a decrease in interest rates. This fosters additional borrowing for investment and consumption, which in turn shifts aggregate demand to the right. The expected outcomes are a short-term increase in real GDP and potentially a higher price level.
Therefore, in the context of a recession, the Federal Reserve should: B) Decrease interest rates to stimulate borrowing and spending. This, in contrast with contractionary monetary policy, would help in reviving economic activity by encouraging both consumers and businesses to spend more, thus stimulating economic growth.
It's important to recognize that monetary policy and fiscal policy should work in tandem to manage the economy effectively. The Federal Reserve has various tools at its disposal, such as open market operations, which target the federal funds interest rate and influence overall economic activity. During the Great Recession, for example, the Fed had to navigate the complexities of working in conjunction with fiscal policy to support the economy.