 # Recessionary Gap Analysis

844 Words4 Pages
Under the recessionary gap, an easy monetary policy should be exercised. In this situation, the Federal Reserve can increase the money supply by lowering the required reserve requirements, buying government securities in the open market operations, and by lowering the discount rate. To increase the money supply, the Federal Reserve has to lower interest rates through the money market. This would cause an encouragement to businesses to do more investment spending, which would shift the aggregate demand curve outwards. In other words, the Fed can increase the money supply by lowering interest rates and stimulating investment spending. 2) Explain the" MONEY MULTIPLIER" of money creation including the formula and the process.(2 points) The money…show more content…
(2 points) A bond is defined by its face value, coupon rate, maturity rate, and tax treatment. Bond prices and interest rates have an inverse relationship. This means that when one goes up, the other one goes down. In other words, when the interest rate goes up, then the present value is going to fall. For example, if I pay a high price to purchase a bond, then a smaller percentage of what I get back counts as interest. Since I am paying more to get this bond, then less of it counts as interest. If I pay less than the face value for a bond, then the rate of return on that bond will be greater than the coupon rate. 5) If RRR (Required Reserve Ratio) is larger, is the Money Multiplier bigger or smaller? Why? Explain its process and based on formula. (2…show more content…
The required reserve ratio is a fraction of reserves set by the Fed that banks are required to hold. This means that if we lower the required reserve ratio, the amount that banks can lend to their customers and the money supply increase. Raising the required reserve ratio causes the money supply and the amount that banks can lend to their customers to decrease. The formula 1/Required Reserve Ratio allows us to prove the information above. If we have a 10% require reserve ratio and we add it to the formula (1/0.10), then we end up with a money multiplier of 10. Ten percent of all the new total reserves are required to be reserved by the bank. If the required reserve ratio is increased to a larger percentage of 50% and is added to the formula (1/0.50), then we end up with a money multiplier of 2. Why does this happen? Well, if the bank is required to withhold 10%, then the amount they can lend is higher. However, when the bank has to hold 50%, then the amount they can lend is lowered because they are withholding fifty percent of all the new total