There are several tools that the Fed uses to implement monet

There are several tools that the Fed uses to implement monetary policy

a. Briefly describe these tools.

b. Explain how the Fed would use each tool in order to increase the money supply.

c. Suppose the federal funds rate equals zero. Does that mean the Fed can do nothing more to stimulate the economy? Explain.

Solution

a. The Fed controls monetary policy in the economy. The tools at its disposal wil include the discount rate, the use of open market operations and also the reserve ratio. The discount rate shows the rate at which central bank loans out to commercial banks. The open market operations shows the buy and sale of bonds by the central bank to try and increase the level of money supply in the economy. The reserve requirements shows how much money the commercial banks will need to keep with the central bank as per the law.

b. If the Fed wants to increase the money supply then it would reduce the discount rate. This would make borrowing more easy and so would raise the money supply. In case the Fed uses open market operations then it can raise the money supply through an open market purchase of bonds from the public. An open market sale would be needed if the aim is to reduce the money supply. If the Fed wants to increase money supply it will also reduce the reserve requirements that the commercial banks need to maintain with the central bank.

c. Even if the Federal funds rate is 0, the Fed can use other measures like open market sales and reducing reserve requirements to stimulate the economy. The Fed can buy back bonds to raise the money supply in the economy.