Question

If Fed wants to add at least $50 billion into the market, what would it do? (Theoretically, there are more than one way. Though you will get credit if you choose other ways, I expect you to give the most practical one)

Answer 1

To add at least $50 billion into the market the Fed would go for Treasury purchases. It will purchase different instruments like bills, notes, TRIPS (treasury inflation-protected securities) and other such instruments across a range of maturities. Thus will pump in liquidity in the system in a direct manner and this is the most practical method that Fed can use.

The Fed would also consider offering repos. Repos are repurchase agreements and Fed can use it to funnel cash into the money markets. In this method Fed will make cash available to the primary dealers and it will do this in exchange for different securities mainly Treasury and other government backed securities. Fed would consider offering overnight repo as well as two-week repo.

Fed would also look at direct lending to banks by lowering the rate that it charges banks for loans from its discount window. This will provide ready access to funding to banks and depository institutions.