Answer to Question #59174 in Macroeconomics for John Rivas

Question

According to the equations PQ=MV and Q; If the Central Bank of a country
wants to stimulate the economy [increase Q] during a recession it must:
A. Increase (Decrease) M by selling (buying)
i. Gold
ii. Stocks
iii. Bonds
iv. Dollars
v. All (none) of the above
B. What can go wrong?
C. Explain how this works.

Answer 1

If the Central Bank of a country wants to stimulate the economy [increase Q] during a recession it must Increase M by buying government bonds issued in the past.
The more money that is available in the market for lending, the lower the rates on these loans become, which causes more borrowers to access cheaper capital. This easier access to capital leads to greater investment and will often stimulate the overall economy. However, the increase in monetery base can lead to the inflation – a decrease of the money’s actual value.
An increase in monetary base means an increase money supply. Therefore by buying bonds the government supplies money to the market.