Now, assume that the Fed has identified a recessionary gap. What type of monetary policy would you...

Now, assume that the Fed has identified a recessionary gap. What type of monetary policy would you recommend? Be specific as to the three tools that the Fed could use to implement this policy.

Expert Solution

Eliminate the recessionary gap Fed would use an expansionary monetary policy. It has mainly three tools which it can use to eliminate the recessionary gap.

Open Market Operatios– Fed would conduct an open market purchase to increase the money supply in the Economy. Increase in money supply so caused would Increase Aggregate Demand, Employment and Output and would eliminate the recessionary gap.
Discount Rate– Federal Reserve Discount Rate is the Interest charged by federal reserve on its loans to banks. To eliminate the recessionary gap, fed would Decrease the discount rate.
Required Reserve Ratio– required reserve ratio is the percentage of Deposits banks must hold as Reserves. To eliminate the recessionary gap Fed will decrease the required reserve ratio so that the commercial banks can create more credit and so that money supply could increase. Increase in the money supply would lead to elimination of the recessionary gap.

Rahul Sunny answered 9 months ago

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