If the Fed increases its open market purchases of government securities,it exerts a downward pressure on the interest rate.Such a phenomenon is usually referred to as the ___________________ effect.

Question

Quizplus · Accepted Answer

The Fed's open market purchases increase the reserves of commercial banks, which leads to an increase in the supply of money in the economy. This increased liquidity puts downward pressure on the interest rates, which is known as the liquidity effect. Thus, option D is the best choice. The income effect refers to a change in demand due to a change in income, substitution effect refers to a change in demand due to a change in relative prices, open market effect refers to the overall impact of the Fed's open market operations, and the expectations effect refers to changes in interest rates due to changes in expectations about future economic conditions.

If the Fed Increases Its Open Market Purchases of Government