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 bank in the economy and it would lead to increase in money supply in the economy because the bank are required to maintain a lower reserve ratio.

when there is a need to maintain lower reserve ratio, the bank are left with more cash to lend to borrowers in the economy and it will increase the money supply in the economy which is a purpose of expansionary monetary policy.

b)Federal Reserve balance sheet has reduced in previous years because it has sold its balance sheet securities and it has also ceased to reinvest the maturing securities.

I am expecting that balance sheet of Federal Reserve to shrink further in coming months because it will have to lend more, as the economy has slowed down and it will have to generate the money supply in the economy by stimulation of demand through lowering of interest rates.

C)Three Statutory objective which have been set by Federal Reserve for monetary policy are as follows-

1. Maximum sustainable development and employment into the economy.

2. Stable prices in to the economy.

3. 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

it affect the rate funds rate because if the Federal Reserve wants to decrease the Fed funds rate, it will have to reduce the interest on reserve and if the Federal Reserve wants to increase the fed Funds rate, it will have to increase the interest on reserve.