A. suppose there is a surge in consumer confidence, creating an increase in aggregate demand in the economy. the federal reserve estimates that a change in the money supply of $120 billion will adjust interest rates enough to offset the change in aggregate demand. if the reserve requirement is 25%, what action should the fed take to reach the desired change in the money supply? the fed should conduct an of $ billion.
b. suppose there is a political crisis in europe, causing a reduction in investment demand in the united states. to stimulate investment demand, the federal reserve decides the money supply needs to change by $150 billion. if the reserve requirement is 10%, what action should the fed take to reach the desired change in the money supply?
the fed should conduct an of $ __ billion.

See below.

Explanation:

For a, first we calculate the credit multiplier of the economy,

Credit multiplier = 1 / reserve ratio

Credit multiplier = 1 / 0.25 = 4

This means that any change in money supply will be 4 times as much in the economy, hence to induce a change of $120 billion, the Fed will decrease the money supply by 120/4 = $30 billion. This will increase the interest rates just enough to stabilize aggregate demand.

For b, we again start by calculating the credit multiplier.

Credit multiplier = 1/0.10 = 10

Since the Fed want to stimulate investment, it needs to use an expansionary monetary policy.

The Fed thus increases the money supply by 150/10 = $15 billion.

This will have the total effect of 150 billion on the whole thus achieving the Fed's objectives.

Hope that helps.

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