Question

What is the primary “Monetary Tool” used by the Federal Reserve?

		adjusting the discount rate
		changing the reserve ration
		open market operations

What are the secondary “Monetary Tools” used by the Federal reserve – (select all that apply)

		adjusting the discount rate
		changing the reserve ration
		open market operations

New Monetary Tools implemented in 2008 by the Federal Reserve included:

		Targeting general areas of the economy.
		Targeting overall areas of the economy.
		Targeting specific areas of the economy.
		Paying interest on bank reserves.
		Charging interest on bank reserves.
		Ignoring interest on bank reserves.

Answer 1

Answer 1.

The correct answer is - Open Market Operations

Explanation - Open market operations is the primary and most commonly used monetary tool by the Federal Reserve. It is the most effective tool to reduce federal fund rates or increase the fed fund rates, which impacts the interest rates in the economy. When the fed pursues expansionary monetary policy, it buys securities from the open market. On the other hand, when the fed pursues contractionary monetary policy, it sells securities in the open market.

Answer 2.

The correct answer is - Adjusting the Discount Rate

Explanation - The discount rate is the secondary monetary tool used by the federal reserve. It is the rate that the fed charges banks for short-term borrowings. When the fed pursues expansionary monetary policy, it lowers the discount rate. On the other hand, when the fed pursues contractionary monetary policy, it increases the discount rates. The reserve ratio is rarely altered by the fed in its policies.

Answer 3.

The correct answer is - Paying Interest on Bank Reserves

Explanation - This is the newest monetary policy tool that has been introduced by the fed after the financial crisis of 2008-09. The central bank pays interest on excess reserves. When the fed wants to encourage credit growth, it lowers interest on excess reserves. Banks therefore find it beneficial to lend than hold excess reserve at the central bank. When the fed wants to lower credit growth, it increases interest on excess reserves. Banks find it attractive to park money with the central bank and earn interest.