Question

Explain how the Federal Reserve influences the quantity of reserves and whether it would be possible without a fractional reserve system. Explain why traditional monetary policy is not currently available for the Fed to achieve its dual mandate (make sure to explain its dual mandate).

Answer 1

Federal reserves buys or sells the treasury securities or other government securities held by the banks to change the reserves held by the banks. If Fed wants to increase the reserves, then it buys securities from the bank and pay funds to increase the reserve and vice versa. When fractional reserve system is not applied, then increase in reserve will be very limited. It will happen, because reserves of the bank, from that the securities is traded will have increase in reserve. Once it is loaned and deposited in another bank, then it will not be able to change the money supply.

The dual mandate is the price stability in the economy and employment generation in the economy, that is to be followed by the Fed. Traditional monetary policy involves expansionary monetary policy, that creates new jobs, but creates inflations also. Though contractionary monetary policy, that controls the price, but it also decreases the jobs in the short run. So, it is said that traditional monetary policy is unable to achieve dual mandate of fed at the same time.