Question

Explain the 3 tools of the fed in its attempt to carry out monetary policy decisions

Answer 1

The tools that the Fed uses to carry out monetary operations are :

1)Discount rate 2) reserve requirement 3) open market operations

1) Discount rate : is the interest rate charged by the Federal Reserve to the commercial banks when they require short term loans.Lowering of the discount rate , leads to expansion in the economy as it encourages lending and spending by businesses and consumers. Increasing the interest rate leads to contractionary economy, as it discourages lending and spending by businesses and consumers.

2) Reserve requirement :is the reserves that the banks have to keep with themselves or with the Federal reserve as deposit. When the reserve requirement decreases, it leads to more funds being available in the economy. When the reserve requirement is increases, less fund are available for the purpose of lending. The government has the authority to change the reserve requirement.

3)Open market operations: this is the buying and selling of treasury securities by the Fed. When the Fed buys treasury there is inflow of funds in the economy which expands the funds available in the economy and when the funds sells, there is lack of funds floating within the economy, this system contracts the funds available in the economy.