Question

GENERAL BUSINESS COURSE QUESTION:

Joe and Jill were talking about the role played by the Federal Reserve System in the United States. Joe seemed to be quite well informed about the functions and activities of our central bank. "You see, Jill, the Fed is the main guardian of our nation's economic stability," Joe declared. "In America, we don't want inflation and we don't want recession. To stretch the situation just a bit, we are frightened, absolutely terrified, by thoughts of hyperinflation and depression. So, the Fed maintains the right to alter the situation and protect us from these two monsters. And you ask, how they do that? The answer is the discount rate. That is the device that the Federal Reserve System uses to keep us safe."

Jill was enjoying listening to her friend explain it all. Joe continued, "Now the discount rate is the interest rate that the twelve Federal Reserve Banks around the country charge their member banks on a loan. So, when the discount rate goes up, all interest rates tend to go up. And, happy to say, when interest rates go up all over America, this tends to slow down any inflationary tendencies." Jill asked, "Does the Fed have other tools for stopping inflation?" "No," said Joe.

2) Joe probably can't answer this question, but you can. What happens in the Fed's open market operations?

Answer 1

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(2) Joe probably can't answer this question, but you can. What happens in the Fed's open market operations?

Besides discount rate, Fed may also use other instruments to monitor or increase consumer money supply. The three monetary-policy instruments of the Federal Reserve are free market activities, discount rate conditions and reserve requirements. The discount rate is the interest rate paid by Federal Reserve Banks for short-term lending to depositary institutions. Reserve provisions are the amounts of deposits banks have to hold either in their vaults or on loan at a Federal Reserve Bank. An open market operation is a central bank action to offer or remove liquidity of its currency to or from a bank or group of banks. Open market operations consist of the acquisition or selling of securities of the government.

Expansionary monetary policy: expansionary monetary policy is used when the economy is weak. This monetary policy's underlying aim is to increase money supply and labor demand by reducing interest rates. These are actions taken by the Fed in conjunction with free market activities in the Expansionary Monetary Policy: as the Fed purchases government securities from debt dealers on the bond exchange, it transfers the payment into the financial accounts of the institutions, companies and persons who sell the debt; these transfers are part of the assets retained by commercial banks in the Federal Reserve and the Federal Reserve.

Since banks want to lend money, they lower interest rates to lure lenders, including the rate banks paying one another for overnight loans (the federal funds rate). Contractionary monetary policy: Inflation is regulated through contractionary monetary policy. This is achieved by increasing the interest rates, rising the economy's overall demand and money supply. Following are the actions taken by Fed in the case of Contractionary Monetary Policy in relation to free market operations: when the Fed sells government securities, investors pay from their bank deposits, which increases the volume of funds kept in their bank accounts; banks then have less liquidity available to lend; The expense of investing more loan because banks have fewer capital to lend, the interest rate goes up and it excludes the federal funds.

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