What are the three monetary policy tools of the Fed Briefly

What are the three monetary policy tools of the Fed? Briefly describe how each tool can be used to implement an expansionary monetary policy and a contractionary monetary policy.

Solution

The three monetary tools that the Fed uses are discount rate, reserve requirement, and open market operations.

Discount rate: It is the interest rate that banks pay on short-term loans from the Fed Reserve bank.The discount rate is generally lower the Federal funds rate.It is is important because it is a visible information of the change in its monetary policy.

Reserve requirement: It is the amount of the p hysical funds that the depository institutions are required to hold against deposits in bank accounts.It is set by the governors of Reserve bank and is usually around 10 percent.

Open-market operations: The Fed constantly buys and sells US government securities in the financial markets which in turn influences the level of reserves in the banking system. When the Fed buys securities through open market operations, it is creating money. Whereas whern it sells securities, it is reducing the money in circulation, which means smaller supply of money in the banking system.

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