Reference no: EM1374272

1. Assume that the Federal Reserve sells government securities from its existing holdings to financial sector and non bank public. Trace by the expected consequences of this secondary market action on banking system - reserves, loanable and investable funds, and deposits; financial markets - bond and stock prices, and interest rates; inflationary pressures; credit-sensitive spending; and the general state of the economy as measured by real GDP (or real income) and unemployment.

2. Deficit spending at the Federal level involves increased government purchases or reduced net taxation with new bonds issued by the United States Treasury. The Treasury must sell these new bonds to the public. The Federal Reserve can allow this without adjusting its own policies or, by combining this sale with open market purchases, it can, in effect, monetize the debt. What are the consequences for interest rates, spending financed by private borrowing, the money supply, the bond supply and inflation from each of these two options for dealing with new Treasury issues? In the second case for simplicity, assume the open market purchase by the Fed matches in value the auction and sale of new Treasury securities.