M4.A2.Macro

The Multiplier Effect

Stephanie Rich

ECO201

August 16, 2014

The Multiplier Effect

The Federal Reserve Board released a press release on December 16, 2009, stating the Federal Reserve was in the process of purchasing agency mortgage-backed securities for $1.25 trillion and roughly $175 billion in agency debt. In addition to the purchases, the FOMC made the decision to gradually reduce “the pace” of Fed purchases. The FOMC believes that economic activity will remain weak however; policy actions will help stabilize financial institutes and markets as well as using monetary and fiscal stimulus; in addition to market forces contributing to the strength of economic growth and the gradual return to higher levels of resource utilization in a context of price stability. The consequences of these policies will limit economic growth, causing inflation to be repressed for quit some time. (Board of Governors of the Federal Reserve System)

The Federal Reserve’s use of open-market operations to influence the money supply does have its consequences. In order to decrease the money supply, the FOMC will sell securities to banks, doing this leads to money being taken out of banks and kept in FOMC reserves. The decrease in money available in the economy leads to a decrease in spending and investment. By limiting the access of capital slows economic growth and reduces investments. If the FOMC wants to increase money supply in the market, they will purchase securities from banks. Doing this allows banks to loan out money to businesses and individuals. When there is an increase in money available in the market, the banks are able to offer lower interest rates, making investments very appealing. By making capital easier to access for businesses and persons stimulates the economy, as are more investors are willing to make a larger investments.

The money multiplier effect has significant effect on the economy. For example, if...