Explain how the Fed's response to inflation works its way through the economy to ultimately affecting real GDP and the price level

What will be an ideal response?

When the Fed is concerned with inflation, the Fed raises the federal funds rate target. To then boost the federal funds rate up to the new target, the Fed conducts open market operations that sell government securities. This sale requires that banks and other purchasers pay for their purchases by using banks' reserves, which decreases the amount of reserves available for banks. The decrease in reserves raises the federal funds rate. It also decreases the quantity of money. The decrease in the quantity of money and bank loans decreases the supply of loanable funds so the real interest rate rises. The higher real interest rate leads to a decrease in the demand for investment and other interest-sensitive sectors of the economy. These decreases mean that aggregate demand decreases so that the AD curve shifts leftward. Following the original decrease in aggregate demand, a multiplier process begins which decreases aggregate demand even further, so that there is a further leftward shift of the AD curve. As a result of the decrease in aggregate demand, the price level falls and real GDP decreases.