Economics Research Paper Example | Topics and Well Written Essays - 750 words

Economics - Research Paper Example For instance, a reduction in the target federal funds rate by the Federal Open Market Committee is quite likely to lead towards a fall in the short term interest rates which are mostly charged on commercial papers and treasury bills among other financial products (Federal Reserve Bank of Richmond, 2012). The short term interests are affected not only by the current federal funds rate but also by the expected overnight changes in the rates (Board of Governors of the Federal Reserve System, 2011). The influence of federal fund rates on the interest rates has been shown in the figure below: Source: Money Cafe (2012) In addition, the changes in the federal funds rate also have certain noteworthy effects on the foreign exchange rates within an economy. For instance, if the fund rates increase in the United States, investing in dollar assets may seem to be more favourable, which in turn may result in the increase of the value of dollar in the foreign exchange market (Board of Governors of the Federal Reserve System, 2011). Furthermore, the Federal Reserve plays a vital role in setting up the monetary policies for a nation which includes the setting up of reasonable long-term interest rates as well. ... One of the major functions of the Federal Reserve is to control the money supply and credit supply in the economy in order to support the economic goals of a nation (Federal Reserve Bank of Richmond, 2012). Likewise, the increase in the federal funds rate might also cause the short term interest rates to rise. This can further lead the business houses and the customers to reduce their expenditures causing a decrease in the economic activities and leading to a fall in the employment rate (Modeste & Mustafa, 2002). A reduction in the in the interest rates of Federal Reserve is likely to result in the decrease in income and output level of the economy. The ‘contraction policies’ implemented by the Federal Reserve is mainly focused on controlling the cumulative demand in an economy. These ‘contraction policies’, have often been observed to lead towards a decrease in the aggregate supply of money within the economy. This results in an increase in the interest rat es which eventually decreases the investment level within an economy leading towards a substantial fall in the overall output level (Khawaja, 2012). The following diagram illustrates the influence of federal funds rate fluctuations on the output gap: Source: (Bivens, 2012) The federal fund rates have significant effect on inflation as well. A decrease in the federal fund rates is likely to result in an increase in the demand for goods and services. This increase in demand for commodities in turn enhances the employment opportunities for labours and requirement for raw materials for the production purpose (Board of Governors of the Federal Reserve System, 2011). This aspect can be evidently observed from