ECONOMICS (CBSE/UGC NET)

Detailed explanation-1: -The Fed should purchase government bonds when unemployment has exceeded the natural rate to decrease interest rates. Lowering interest rates increases borrowing, enabling the economy to recover from increased unemployment rates because it influences money supply appreciation.

Detailed explanation-2: -Consider, first, why the Fed buys bonds to boost growth and inflation. Bond-buying, or “quantitative easing” (QE), works via the so-called credit channel. That is, it encourages banks to lend more. When the Fed buys bonds from banks, their cash reserves at the Fed go up.

Detailed explanation-3: -The answer is b) M1. If the Fed buys government bonds, M1 will likely NOT increase.

Detailed explanation-4: -When the Federal Reserve buys bonds, bond prices go up, which in turn reduces interest rates. Open market purchases increase the money supply, which makes money less valuable and reduces the interest rate in the money market. OMOs involve the purchase or sale of securities, typically government bonds.

Detailed explanation-5: -If the Fed buys bonds in the open market, it increases the money supply in the economy by swapping out bonds in exchange for cash to the general public. Conversely, if the Fed sells bonds, it decreases the money supply by removing cash from the economy in exchange for bonds.