Question

The Fed announced in September 2013 that it would postpone winding down its monetary stimulus until the economic recovery was stronger. When the Fed does finally begin to reduce bond purchases?
a. interest rates will rise.
b. interest rates will fall.
c. stock prices will rise.
d. bond prices will rise.

Answer 1

Answer:

A) interest rates will rise.

Explanation:

When the FED buys US securities it is carrying out an expansionary monetary policy. It reduces the interest rate of US securities so that more investors are willing to sell their US securities to the FED since their rate of return is very small.

If the FED stops buying back US securities, it means that they will stop their expansionary monetary policy, so the FED will start to increase US securities' interest rates. That way investors will be willing to keep their US securities and will not sell them since their rate of return has increased. This increase in the interest rate will lower the price of US securities and decrease the money supply.