Question

(8) Consider the Federal Reserve’s ability to engage in open market operations. What are open- market operations and if the Federal Reserve’s goal is to increase the money supply, then how might it use open market operations to achieve that goal?

Answer 1

Federal reserve:- The Federal Reserve System (also known as the Federal Reserve or simply the Fed) is the central banking system of the United States of America. It was created on December 23, 1913, with the enactment of the Federal Reserve Act, after a series of financial panics (particularly the panic of 1907) led to the desire for central control of the monetary system in order to alleviate financial crises. Over the years, events such as the Great Depression in the 1930s and the Great Recession during the 2000s have led to the expansion of the roles and responsibilities of the Federal Reserve System. The U.S. Congress established three key objectives for monetary policy in the Federal Reserve Act: maximizing employment, stabilizing prices, and moderating long-term interest rates. The first two objectives are sometimes referred to as the Federal Reserve's dual mandate. Its duties have expanded over the years, and currently also include supervising and regulating banks, maintaining the stability of the financial system, and providing financial services to depository institutions, the U.S. government, and foreign official institutions.The Fed also conducts research into the economy and provides numerous publications, such as the Beige Book and the FRED database.

The Federal Reserve uses open market operations to arrive at the target rate. Open market operations consists of the buying or selling of government securities. The Fed holds government securities, and so do individuals, banks, and other financial institutions such as brokerage companies and pension funds. Open market operations deals with buying and selling of government securities in open market.

The U.S. Federal Reserve conducts open market operations—the buying or selling of bonds and other securities to control the money supply. With these transactions, the Fed can expand or contract the amount of money in the banking system and drive short-term interest rates lower or higher, depending on the objectives of its monetary policy.The Importance of Open Market Operations in money supply,Open market operations are one of three key tools the Fed uses to achieve its policy objectives, and arguably the most powerful and frequently used. (The other two tools are banks' reserve requirement ratios and the terms and conditions for bank borrowing at the Fed's discount window.)Conducted by the trading desk at the Fed's New York branch, open market operations enable the Fed to influence the supply of reserves in the banking system. This process then affects interest rates, banks' willingness to lend and consumers' and businesses' willingness to borrow and invest.open market operations are an important toll to increase the money supply in the economy. When their is large supply of money in the economy their is much production in the economy which will boost the employement level in the economy. Open market operations also help in checking the excess flow of money supply.

The FED will undertake contractionary monetary policy when the economy is overheating and inflation is reaching the limit of its comfort zone. During recession or economic downturn, the FED will seek to expand the supply of money in the economy , with a goal of lowering the federal funds rate- the rate at which banks lend to each other overnight.