Question

1. Identify and briefly explain the threemajor tools that the Federal Reserve can use to implement monetary policy.
2. Which of these tools is the most effective and why?
3. How would the mechanism(s) described in part b. above be used to stimulate (expand or grow) or to contract (slow down) the economy?

Answer 1

1.Federal Reserve can use interest rate in order to control with the fluctuations in the economy and it can use interested to control with the inflation in the economy and stimulate the demand in the economy and control the money flow in the economy

ii. Federal Reserve can also increase or decrease the reserve ratio requirement of the bank in order to control with the flow of loan.

iii. federal reserve can also enter into open market operations in order to control with flow of money.

2. interest rate tool is most effective because it is leading to control of demand and supply in the economy and it is leading to to proper outcome as intended by the Federal Reserve.

3. interest rates can be increased and Reserve requirement can be increased and Federal Reserve can sell the securities in the market when it will feel that the markets should be cutting down on the money flow.

When the Federal Reserve wants to increase the money flow then, it will lower the rate of interest and lower the Reserve requirement of the bank and it will also purchase the securities from the market in order to increase liquidity.