1. List three main tools available to the Fed to change the money supply in the...

1. List three main tools available to the Fed to change the money supply in the economy.

Which tool do you think is most commonly used?

If the Fed wanted to decrease money supply in the economy, would the Fed buy or sell securities in the open market?

What would be the first effect of this policy?

Solutions

Expert Solution

Three main tools are-

1) Open market operations i.e. central bank buys or sells securities to country's private banks. These purchases have effect on bank's reserves and therefore ultimately it effects the money supply.

2) Reserve requirement- central bank requires each bank to hold some percentage of reserves in hand. The excess reserve are loaned out and effects the money supply. But the excess reserve depends on the required reserve ratio.

3) Discount rate- it is the rate that CB charges it's members to borrow at its discount window.

Open market operations is the most commonly used tool by the Fed, where they increase(or, decrease) interest rate by selling (or, buying) securities.

If the Fed wants to decrease money supply, it should sell securities in the open market i.e. selling securities in exchange of money.

If Fed sell securities, they will increase interest rate, so that Banks find it more profitable to buy securities from the Fed.

Rahul Sunny answered 1 year ago

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