Question 37

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

To expand aggregate demand, the Federal Reserve (Fed) implements policies that increase the money supply and lower interest rates, making borrowing cheaper and encouraging spending and investment.

A) Decrease the money supply

Decreasing the money supply would contract aggregate demand, as it limits the amount of money available for consumers and businesses to spend. This action would likely lead to higher interest rates, further discouraging borrowing and spending.

B) Increase the money supply

Increasing the money supply directly contributes to expanding aggregate demand by making more funds available for consumption and investment. This policy lowers interest rates, encouraging borrowing and spending, which stimulates economic growth.

C) Reduce the quantity of reserves

Reducing the quantity of reserves would typically lead to a tighter monetary policy, which does not expand aggregate demand. This action would restrict the banks' ability to lend, ultimately resulting in decreased spending and investment.

D) Lower the interest rate

Lowering the interest rate is a key tool used by the Fed to expand aggregate demand. By making borrowing cheaper, it incentivizes consumers and businesses to take loans for consumption and investment, thereby stimulating economic activity.

E) Increase the foreign exchange rate

Increasing the foreign exchange rate generally makes domestic goods more expensive for foreign buyers, potentially decreasing exports and negatively impacting aggregate demand. This option does not directly contribute to expanding demand in the domestic economy.

F) Raise mortgage rates

Raising mortgage rates would have the opposite effect of expanding aggregate demand, as higher mortgage rates would deter home buying and reduce consumer spending. This would contract, rather than expand, economic activity.

Conclusion

The correct options, increasing the money supply and lowering the interest rate, are effective strategies employed by the Fed to stimulate aggregate demand. All other options either restrict the money supply or negatively impact borrowing, which would not support the goal of enhancing economic activity.