Question

The Federal Reserve uses three main tools for monetary policy changes .How could we discuss about it ?

Answer 1

The three main tools Federal Bank uses as an monitary policy approach are-

1. Open Market operations
2. Reserve Requirement
3. Discount rate

Open Market operations- Open market operations involves the Federal bank to Buy or sell government securities in open market thus controlling their reserves as well control liquidity with the Banks since, if Fed buys government securities from banks it will provide them with more liquidity to lend and hence is an expansionary approach whereas if Fed sells securities this will lead to decrease in liquidity in hands of bank

Reserve Requirement- This is the second tool where Federal bank controls the reserves Bank needs to keep with themselves Higher the reserves more liquidity is tied up in lending and hence lesser liquidity to lend and vice versa.Fed rate are rates set by Federal bank which allows the bank to borrow from other bank to fulfill their reserve requirement. Higher the fed rates costlier are the funds hence is the contractionary approach and vice versa

Discount rate- These are the rates at which Federal Bank lands it to other Banks and these rates are higher than Fed rates so generally only the Banks who are in distress and can not borrow from other bank uses this again higher the rate contractionary is the monetary policy.