Question

. Assume you are the chairman of the Board of Governors of the Federal Reserve. The economy is in the midst of a recession. What type of monetary policy would you advocate? What tools would you use to implement said policy? Be specific in your response as to how the tools would work to accomplish your objectives.

Answer 1

In the times of recession the economic growth become very low and there will be an increase in the unemployment in the economy. Overall the economy lag behind, so the while taking a monetary money it must be expansionary monetary policy.  An expansionary monetary policy increases the money supply in the economy and there by increases the aggregate demand in the economy and increases the output of the economy. The central bank can implement the expansionary policy by using the various tools.

1. Open market operations- The open market operations are the activities of buying and selling government securities in the market. In a period of recession the central bank would the sell the securities so it is an injection of money in to the economy.

2. Federal funds rate- The federal funds rate are the interest rates charged by the Fed for the overnight transaction between the depository institutions in the economy. The depository institutions uses this for maintaining their required reserve ratio. So if the if the interest rate is low these institutions can borrow more funds so this increases their excess reserves. The increase in the excess reserve menas they can lend more to the general public. In a recession the Fed decreases the federal funds rate.

3. Discounte rate- The discount rate is the interest rate charged for borrrowing from the central bank by the commercial banks . In the other words it is the rate at which the centarl bank lends to the commercial banks. If the interest rate is low the commercial banks can borrow more money from Fed at a low cost. So in a recession the Fed lowers the discount rate.

The more to the banks means they can lend more money to the public and increase the money supply in the economy.