Question

1) What are the three intruments of mentary corntrol? Explain each.

2) Why does the Fed prefer to use open market operations? Explain.

3) Explain how the Federal Reserve can use its open market operations to expand or contract bank reserves and the money and credit supply.

4) Describe the chain of command in the federal Reserve that overseas its open market operations.

5) Give a detailed account of how monetary policy works to impact interest rates and the macroeconomy.

Answer 1

1) Tools of the Fed to control the money supply are:

1. Open market operation: Open market operation is the sale and purchase of government securities in the open market by the central bank. By selling the securities, the central bank withdraws cash balances from the economy. And, by buying the securities, the central bank adds to cash balances in the economy. During inflation, central bank sells government securities and reduce the money supply and on the other hand, during deflation, central bank buy government securities.

2. Reserve requirement: It refers to the minimum percentage of a bank's total deposits required to be kept with the central bank. Commercial banks have to keep with the central bank a certain percentage of their deposits in the form of cash reserves as a matter of law. When the flow of credit is to be increased, minimum reserve ratio is reduced and vice-versa.

3. Discount rate: It is the minimum interest rate charged by the Fed for lending to commercial banks. To increase money supply, the Fed reduces discount rate and vice-versa.