Federal Reserve bond purchases and expansionary monetary policy effects

¶ … Federal Reserve buys government bonds, it increases the overall money supply in the nation and thus pursues an expansionary monetary policy. Through buying bonds the Fed increases the amount of reserves in the banking system, leading to more loans and hence more deposits. Since deposits are part of the money supply, the money supply increases. This is often done in combination with lowering interest rates to speed up the economy by infusing it with a larger available supply of money to spend upon consumer goods.

Conversely, by selling government bonds and reducing interest rates, the Federal Reserve reduces the overall money supply. The money supply is determined by the amount of currency and bank deposits held by the public, as well as the amount of reserves held by banks. When prices and inflation are going up, the Federal Reserve tries to slow down the economy by making fungible money scarcer, through the selling of bonds, and also by making it more attractive for individuals to save with high rates of interest.

Usually, most consumer-based industries prefer low rates of interest, to encourage people to spend more and to buy more goods. However, banks often prefer higher rates of interest, as people are encouraged to save more and 'give' or loan more money to the bank.

Question 2