Question

When the Federal Reserve increases the money supply, this action reduces the value of money.

Answer 1

Therefore aggregate demand will increase. The reverse will be true when money supply decreases. That is a decrease in the money supply will lead to a decrease in the amount of money that people and firms will hold and as a result they will spend less. This will cause aggregate demand to decrease.The three major tools of the Fed are open market operations, changing reserve requirements, and changing the discount rate. If the Fed wants to stimulate the economy (increase aggregate demand), it will increase the money supply by buying government bonds, lowering the reserve ration, and/or raising the discount rate.Lastly, the Fed can affect the money supply by conducting open market operations, which affects the federal funds rate. In open operations, the Fed buys and sells government securities in the open market. If the Fed wants to increase the money supply, it buys government bonds.