aq18Mar3 - c Short term interest rates will fall yes that...

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18 March If the Fed announces today a lower target for the Federal Funds Rate, what will actually happen is: a. The Fed will buy more existing government bonds, thereby increasing the supply of reserves to the banking system: true, that is how the money supply and the supply of reserves available to the banks are expanded. The Federal Funds Rate is the interest rate on loans of reserves between banks; the Fed reduces it by making more reserves available, i.e. increasing the supply of reserves. It does that by buying bonds, because what it pays for the bonds are its IOU’s, i.e. reserves. b. The Fed will sell some existing government bonds it holds, thereby increasing the supply of reserves to the banking system: no, wrong.
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Unformatted text preview: c. Short term interest rates will fall , yes, that is the point. d. Short term interest rates will rise: no, wrong. e. Long term interest rates may or may not change, depending on what happens to expectations of inflation: this is correct; the major determinants of long term interest rates are the real interest rate and the expected inflation rate. f. If expectations shift so more people expect inflation to accelerate, short term interest rates will fall but long term interest rates could rise: this is also correct, just spelling out e. in more detail. g. If expectations shift so more people expect inflation to accelerate, short term interest rates will rise but long term interest rates will fall. No, this is wrong....
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