Question

SUPOPSE THA TTHE FOMC DECIDES TO RAISE THE TARGET FOR THE FEERAL FUND RATE LATER THIS YEAR. WHAT TOOLS ARE AVAILBLE TO ACHIEVE THIS? ILLISTATE

Answer 1

1. Open Market Operations

Open market operations are when central banks buy or sell securities. These are bought from or sold to the country's private banks. When the central bank buys securities, it adds cash to the banks' reserves. That gives them more money to lend. When the central bank sells the securities, it places them on the banks' balance sheets and reduces its cash holdings. The bank now has less to lend. A central bank buys securities when it wants expansionary monetary policy. It sells them when it executes contractionary monetary policy.

Quantitative easing is open market operations on steroids. Before the recession, the U.S. Federal Reserve maintained between $700 to $800 billion of Treasury notes on its balance sheet. It added or subtracted to affect policy, but kept it within that range. QE nearly quintupled this amount to more than $4 trillion by 2014.

2. Reserve Requirement

The reserve requirement refers to the money banks must keep on hand overnight. They can either keep the reserve in their vaults or at the central bank. A low reserve requirement allows banks to lend more of their deposits. It's expansionary because it creates credit.

A high reserve requirement is contractionary. It gives banks less money to loan. It's especially hard for small banks since they don't have as much to lend in the first place. That's why most central banks don't impose a reserve requirement on small banks. Central banks rarely change the reserve requirement because it's expensive and disruptive for member banks to modify their procedures.

Central banks are more likely to adjust the targeted lending rate. It achieves the same result as changing the reserve requirement with less disruption. The fed funds rate is perhaps the most well-known of these tools. Here's how it works. If a bank can't meet the reserve requirement, it borrows from another bank that has excess cash. The interest rate it pays is the fed funds rate. The amount it borrows is called the fed funds. The Federal Open Market Committee sets a target for the fed funds rate at its meetings.