In: Finance
Describe the tools the Fed has in its toolbox.
Main monetary tools the FED uses:
1. Managing Interest rate : It has the power to increase or
decrease interest rates and hence decreasing or increasing money
supply to the economy.
2. Open Market Operation: By purchasing or selling securities in
open market operation FED can opt for expansionary or
contractionary monetary policy.
3. Reserve Requirement : By increasing the reserve requirements for
the bank the FED can reduce money supply and by reducing reserve
requirement for banks it can increase money supply.
The monetary policy by decreasing money supply can reduce
inflation or vice versa. The reduction in money
supply reduces demand for funds. It can stimulate growth and
employment by increasing money supply. This can be achieved by
purchasing securities in OMO , or reducing interest rates and
lowering reserve requirements.
Agency relationship is the case where certain agents or managers
perform on behalf of the owners . The agents follow instructions by
owners and act accordingly. They are controlled by the
owners.