Suppose the economy is experiencing a recession and high unemployment. What would be the interpretation of how an expansionary monetary policy would address this problem?

What will be an ideal response?

With an expansionary monetary policy, the Federal Reserve buys bonds, lowers the reserve ratio, lowers the discount rate, or reduces the interest rate on reserves. As a consequence of these actions, excess reserves increase, that in turn increases the money supply. When this happens, interest rates fall, investment spending increases and aggregate demand increases. The end result is a rise in real GDP by a multiple of the increase in investment.