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True or False:  If the Fed is worried about overheating (GDP growing too fast,...

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lilylee | Student, College Freshman | Salutatorian

Posted July 1, 2013 at 12:52 PM via web

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True or False:  If the Fed is worried about overheating (GDP growing too fast, inflationary pressures building), then the appropriate open market operation would be for the Fed to conduct open market sales.

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted July 1, 2013 at 1:21 PM (Answer #1)

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This statement is true.

Open market operations are one of the major tools of monetary policy that the Federal Reserve (the Fed) can use to try to influence the economy.  The Fed’s main role is to use monetary policy to try to maintain steady economic growth with low inflation.

In open market operations, the Fed can either buy or sell government securities.  When the Fed buys government securities, it pumps money into the economy because it is giving banks money in exchange for their securities.  When the Fed sells government securities, it takes money out of the economy because it is taking money from the banks and giving them government securities (which cannot be used as cash) in return.

When the Fed worries that the economy will overheat, it wants to take money out of the economy.  When it does this, there will be less lending and borrowing and therefore less economic activity.  This will reduce GDP growth and reduce the likelihood of inflation.

Therefore, in this situation, the Fed should sell government securities.  This means the statement is true.

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