Final answer:
To balance an increase in investor confidence and demand for new plants and equipment, the Federal Reserve would likely implement a contractionary monetary policy, such as selling bonds or raising the federal funds rate, not increasing taxes.
Step-by-step explanation:
When there is an unexpected increase in investor confidence leading to an increased demand for new plants and equipment, this scenario suggests an expansion in the economy which may risk increasing inflation if not controlled. The Federal Reserve (the Fed), which aims to maintain stable interest rates and control inflation, would need to counteract this by implementing a contractionary monetary policy. To achieve this, the Fed could sell bonds to reduce the money supply, or it could increase the federal funds rate, thereby making borrowing more expensive and cooling off investment and spending.
In the given situation, the Fed's primary goal would be to prevent the economy from overheating and to keep inflation in check without triggering a slowdown in economic growth. It's important to note that the Fed does not have the power to increase taxes, as this function resides with the legislative bodies of government. Therefore, the statement indicating that the Fed should increase taxes to stabilize interest rates is incorrect. Tax adjustments are fiscal policy measures that fall under the domain of the government and not the Federal Reserve.