Question

Is the Federal Reserve able to manipulate our country’s monetary supply through Open Market Operations to accumulate a large amount of money within a short-period of time? Please explain. Does the Federal Reserve Requirement Ratio vary depending on the financial holding of financial institutions?

Answer 1

Part a) Yes, the Federal Reserve is able to manipulate the monetary supply in the US through Open Market Operations.

For example, if the Fed believes that there is too much liquidity in the market or inflation is beyond the acceptable limit, then it can reduce the money supply through open market operations. The Federal Reserve in such a situation sells government bonds to the commercial banks, as a result of which the amount of money available with the banks for lending declines. This reduces the money supply in the economy.

The opposite is true when the Federal Reserve decides to buy government bonds from commercial banks, thereby increasing the money supply.

Part b) No, the Federal Reserve Requirement Ratio does not vary depending on the financial holding of financial institutions. The reserve requirement is part of the monetary policy tool with the Federal Reserve. It is used depending upon the current state of economy.

For instance, if the economy is under recession, then the Federal Reserve will reduce the reserve requirement ratio to increase the money supply in the economy. This happens because with more funds for lending, the banks will be able to lend more to businesses for investment and to consumers for consumption, thereby boosting economic activity.