Final answer:
The Fed influences the money supply and interest rates. Changes in the federal funds rate affect economic activities, with higher rates discouraging borrowing and spending, and lower rates encouraging them. The Fed targets macroeconomic variables to manage the economy but avoids directly targeting asset prices like stock or real estate values.
Step-by-step explanation:
Federal Reserve's Influence on the Economy
The Fed, short for the Federal Reserve, primarily influences the money supply and interest rates. Its actions, such as changing the federal funds rate, directly affect domestic interest rates. A rise in the Fed's rate typically leads to higher interest rates, which can curb borrowing and spending, slowing down the economy to control inflation. Conversely, when the Fed lowers interest rates, it encourages borrowing and spending, which can stimulate economic growth. Choosing the right target or set of targets for monetary policy is crucial and often includes a focus on interest rates.
When discussing how monetary policy affects the financial markets, a rise in the supply of money tends to lead to a decline in interest rates. An expansionary monetary policy, where the Fed buys bonds to increase the money supply, results in lower interest rates and stimulates economic activities like investment and net exports.
Choosing Targets for Monetary Policy
The Fed bases its policy decisions on macroeconomic targets such as interest rates, money growth rates, and inflation levels. Adjusting the money supply influences these targets, aiming to achieve a stable and growing economy. However, the Fed generally refrains from targeting asset prices directly, such as stock prices or real estate values, due to the controversial nature and difficulty of accurately gauging 'correct' price levels.