Question 30

The Fed expands aggregate demand by lowering the interest rate and increasing the money supply.

By lowering the interest rate and increasing the money supply, the Federal Reserve makes borrowing cheaper and encourages spending and investment, thereby expanding aggregate demand.

A) Lower the interest rate

Lowering the interest rate makes borrowing less expensive for consumers and businesses, which can lead to increased spending and investment. This directly stimulates economic activity and expands aggregate demand.

B) Decrease the money supply

Decreasing the money supply would likely lead to higher interest rates, which discourages borrowing and spending. This action would contract, rather than expand, aggregate demand, making it an incorrect choice for this question.

C) Reduce the quantity of reserves

Reducing the quantity of reserves would limit the banks' ability to lend, potentially leading to higher interest rates. This would not support an expansion of aggregate demand, thus making this option incorrect.

D) Raise mortgage rates

Raising mortgage rates would increase borrowing costs for consumers looking to finance home purchases, thereby reducing spending in the housing market and overall economic activity. This would not expand aggregate demand and is therefore incorrect.

E) Increase the foreign exchange rate

Increasing the foreign exchange rate would make domestic goods more expensive for foreign buyers, potentially reducing exports. This could negatively impact aggregate demand, making this option incorrect.

F) Increase in money supply

Increasing the money supply enables banks to lend more, which lowers interest rates and promotes consumer and business spending. This directly contributes to the expansion of aggregate demand, making it a correct choice.

Conclusion

The correct answers, lowering the interest rate and increasing the money supply, are essential tools used by the Federal Reserve to stimulate economic activity and expand aggregate demand. The other options either contract demand or do not effectively contribute to its expansion, highlighting their inappropriateness in this context.