How can the Fed use its powers to encourage or discourage business activity?

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

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The Federal Reserve can use its powers to manipulate business activity by raising or lowering the money supply.  This is one of its main responsibilities.

When the Fed wants more business activity to happen, it raises the money supply.  It can do this in a variety of ways.  The two most common are by lowering interest rates or by buying government securities.  If the Fed lowers interest rates, it becomes easier and cheaper for companies to borrow money.  Therefore, they borrow and spend more.  This increases the level of business activity.  If the Fed buys government securities from banks, it is giving them money that they did not have before.  The banks will want to lend that money, again, more lending means more business activity.

If the Fed thinks that there is too much business activity (which means that it is worried that excessive inflation will occur) it will take the opposite steps.  It will raise interest rates and/or it will sell government bonds.  This will take money out of the economy and make it harder for banks and people to borrow.

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