Question

1. Monetary policy tools :(Don't write on paper I need to cope in to word doc)

a. What are the conventional monetary policy tools of a central bank.

b. How can these conventional tools be used to stimulate the economy?

c. When can a central bank be forced to turn to unconventional monetary policy tools?

d. Please describe two unconventional monetary policy tools used by the central banks globally in the aftermath of the recent financial crisis?

Answer 1

1) The Fed can use four tools to achieve its monetary policy goals: the discount rate, reserve requirements, open market operations, and interest on reserves. All four affect the amount of funds in the banking system.

• The discount rate is the interest rate Reserve Banks charge commercial banks for short-term loans.

Reserve requirements are the portions of deposits that banks must hold in cash, either in their vaults or on deposit at a Reserve Bank.

• Open market operations, the buying and selling of U.S. government securities, has been a reliable tool.

• Interest on Reserves is the newest and most frequently used tool given to the Fed by Congress after the Financial Crisis of 2007-2009. Interest on reserves is paid on excess reserves held at Reserve Banks. Remember that the Fed requires banks to hold a percentage of their deposits on reserve.

2) Conventional monetary policy is a set ofinstruments available to a central bank to control the money supply level. These include instruments that have been used by all central banks since their inception.

Conventional monetary policy is structured around 3 axes: open market operations, standing facilities and minimum reserves.

The discount rate is the interest rate Reserve Banks charge commercial banks for short-term loans. Federal Reserve lending at the discount rate complements open market operations in achieving the target federal funds rate and serves as a backup source of liquidity for commercial banks. Lowering the discount rate is expansionary because the discount rate influences other interest rates. Lower rates encourage lending and spending by consumers and businesses. Likewise, raising the discount rate is contractionary because the discount rate influences other interest rates. Higher rates discourage lending and spending by consumers and businesses. Discount rate changes are made by Reserve Banks and the Board of Governors.

• Reserve requirements are the portions of deposits that banks must hold in cash, either in their vaults or on deposit at a Reserve Bank. A decrease in reserve requirements is expansionary because it increases the funds available in the banking system to lend to consumers and businesses. An increase in reserve requirements is contractionary because it reduces the funds available in the banking system to lend to consumers and businesses. The Board of Governors has sole authority over changes to reserve requirements. The Fed rarely changes reserve requirements.

• Open market operations, the buying and selling of U.S. government securities, has been a reliable tool. As we learned earlier, this tool is directed by the FOMC and carried out by the Federal Reserve Bank of New York.

c)  During periods of extreme economic crisis, traditional monetary policy tools may no longer be effective in achieving their goals. Unconventional monetary policy, such as quantitative easing, may then be employed to jump-start economic growth and spur demand.

d) The tools of unconventional monetary policy include: ZIRP (Zero Interest Rate Policy); QE (Quantitative Easing); CE (credit easing); Negative Interest Rates.