Question

The Fed has pledged to support smooth market functioning and effective transmission of monetary policy.

(a) Discuss how the Fed may use reserve ratio to implement an expansionary monetary policy.

(b) Explain why the Fed’s balance sheet has reduced in 2018-2019. How would you expect the trend of Fed’s asset size in the coming months?

(c) What are the three statutory objectives for monetary policy set by the Fed?

(d) What is IOR? How does it affect the fed funds rate?

Answer 1

a) Federal Reserve may use reserve ratio to implement an expansionary monetary policy by reducing the reserve ratio for commercial banks in the economy and it would lead to increase in in money supply in the economy because the bank are required to to maintain a lower reserve ratio.

When there is a need to maintain lower reserve ratio the bank are are left with more cash to lend to borrowers in the economy and it will increase the money supply in to the economy living into a expansionary monetary policy

b) Federal Reserve balance sheet has reduced in previous year becauseit has sold its balance sheet securities or it has ceased to reinvest the maturing securities.I expect the balance sheet of Federal Reserve to shrink further in coming months because it will have to lend more as the economy have slowed down and it will have to generate the money supply in the economy by lowering the interest rates.

C) three statutory objective which has been set by federal reserve are maximum sustainable employment in the economy and stable prices in the economy along with moderate long term interest rates.

D) interest on reserve is the rate at which Federal Reserve pay interest on reserve balances which are held by commercial banks so if the Federal Reserve wants to decrease the fund rate it will have to reduce the interest on reserve.