Question

• How can the Federal Reserve System create new excess reserves (or destroy existing excess reserves)?
• How do the actions of the Federal Reserve alter economic conditions?

Answer 1

Part A

Federal Reserve System will create new excess reserves by reducing the reserve ratio so that commercial banks and other financial institutions can create more money to the economy.The excess reserves would be destroyed when the reserve ration is increased.The monetary tools applied by the federal reserve are ether expansionary which creates new excess reserves and contractionary policies in order to destroy excess reserves.

Explanation:

Part B

How they alter economic conditions.

For the new excess reserves, there would be an increased money supply which reduces the level of interest rates.Lower rates will attract more investors, and the cost of production would reduce which tends to reduce the prices of goods.Lower prices increases consumption and exportation which stimulates the economy.

When excess reserves are destructed, the money supply reduces in an economy which increases the interest rates. This leads to high cost of borrowing hence pushing the investors away.The resultant price of goods increase which leads to lower consumption and exportation, this reduces the economic growth of the country.