Question:
•Suppose that in an effort to stimulate the economy, the Federal Reserve decided to
engage in an open market operation to expand the M2 money supply by 10%. What
are some potential drawbacks of such a move?
•Instead of engaging in open market operations, suppose the Fed simply printed an
extra $500 billion and disbursed it equally among the population. Why is this a
problem?
•Briefly explain the impacts of increasing the reserve requirement ratio on banks.
•Why are decisions by the FOMC regarding changes in the overnight lending rate so
closely followed by the financial markets?
1. Suppose that in an effort to stimulate the economy, the Federal Reserve decided to
engage in an open market operation to expand the M2 money supply by 10%. What
are some potential drawbacks of such a move?
There could be potential problems with expanded the M2 money supply by 10% in the
open market operations. The M2 includes M1 plus saving deposits, including MMDAs,
small-denominated time deposits, and MMMFs held by individuals. The open market
operations consists of buying government bonds from, or selling government bonds to
commercial banks and the general public. An example of some of the problems that could
arise would be if credit cards would increase by 10%, which in not classified as M1 money
(currency and checkable deposits). Credit cards are merely a means of postponing payment
of a good, and will later refund the bank for the purchase at a later time. If an individual
happens to be unable to repay this temporary loan to the bank, this results in the bank
