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1. Recently the Federal Reserve began a plan to begin selling off bonds: Graphically show the...

1. Recently the Federal Reserve began a plan to begin selling off bonds: Graphically show the effect on the value of money when the fed engages in this strategy. Be sure to note any inflation or deflation seen in the market in the appropriate location on the graph.

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Answer #1

When the Federal Reserve plans to selling off bonds, this decreases the money supply. Graphically, it is shown as a leftward shift of LM curve. Due to this, the value of money increases, the interest rate increases. This also leads to a decrease in the aggregate demand because decrease in money supply will lead to decrease in consumer spending. This is shown in the graph as AD curve shifting leftward.

The effect on inflation is visible in the bottom part of the graph. The prices fall from P1 to P2. Hence monetary contraction is used to dampen inflation.

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