Question

What policy instruments does the Fed use for the monetary policy?

What are the pros and cons of using expansionary and contractionary monetary policy tools under the following scenarios: depression, recession, inflation, and robust economic growth? Which do you think is more appropriate today?

Answer 1

The Fed can use three tools to achieve its monetary policy goals: the discount rate, reserve requirements, open market operations, and interest on reserves.

During a recession or deflation, central banks use contractionary monetary policy as central banks decrease the money supply through monetary policy, and this can have both positive and negative impacts on an economy.

Negative effect- the use of contractionary monetary policy during a recession would cause the economy to collapse into more disorder and if money supply declines, this would also reduce the expenditure due to a lack of funds, leaving an economy in depression.

Positive effect- On the other hand, it's possible to use contractionary monetary policy to support a healthy economy. If an economy faces high inflation, then contractionary monetary policy will help to lower the rate of inflation by increasing the interest rate to make borrowing more expensive.

During recession or deflation in this central bank, central banks use expansionary monetary policy to increase money supply in an economy, as well as having a positive and negative effect on the economy.

Positive effect-expansionary policy is used to raise the size of money supply and can aid in deflation by reducing taxes and decreasing interest rates. People therefore welcomed family, company loans, and this would increase the rate of economic development.
Negative effect- expansionary policy will increase the stock of money in an economy and thus, if there is strong economic growth, it will result in lower currency value, reducing the exchange rate.