Question

Federal Reserve monetary policy strives to bring about full employment and price stability. Explain how the Federal Reserve loosens or tightens monetary policy through open market operations and how this affects the economy. Include in your answer how looser or tighter monetary policy affects the amount of reserves in the banking system and interest rates, and how loose or tight monetary policy is supposed to affect GDP, employment and inflation.(8-12 sentences)

Answer 1

Federal reserve monetary policy major objective is to attain economic growth via full employment and by stabilizing prices. Therefore central bank adopts expansionary and contractionary fiscal policy.

Expansionary monetary policy deals with increase in money supply by reducing interest rate, ratios .while, contractionary monetary policy deals with decrease in money supply by increasing interest rate , ratios.

open market operations deals with the sale and purchase of government securities. In case of expansionary monetary policy, in order to increase money supply, federal reserve buys government securities . While, In case of contractionary monetary policy, in order to decrease money supply , federal reserve sells government securities.

With the expansionary monetary policy, interest rates are reduced by the Federal Reserve and banks have more ability to create credit. At the same time , in expansionary monetary policy , cash reserve ratio is decreased and excess reserves with commercial banks increased and due to which money supply increased . Due to expansionary monetary policy interest rate falls , with fall in interest rate investment activities increases, output increases and there is increase in employment. and inflation will increase.

With the contractionary monetary policy , interest rates are increased by the federal reserve and banks have less ability to create credit. At the same time , in contractionary monetary policy , cash reserve ratio is increased and excess reserves with commercial banks decreased and due to which money supply decreased . Due to contractionary monetary policy interest rate rises , with increase in interest rate investment activities falls, output falls and there is decrease in employment. and inflation will fall.