Question

Federal Reserve monetary policy strives to bring about full employment and price stability. Explain how the Federal Reserve loosens or tightens monetary policy through open market operations and how this affects the economy. Include in your answer how looser or tighter monetary policy affects the amount of reserves in the banking system and interest rates, and how loose or tight monetary policy is supposed to affect GDP, employment and inflation.(8-12 sentences)

Answer 1

Answer - While using the open market operation tool , the fed either buys the government securities or sells them.

In the case where the fed had to control inflation and reduce the money supply , it sells the securities to the open market and banks. This , decreases the amount of reserves in the banks , reduces the amount of money in the economy , increases the interest rates. Thus the money supply is decreased and inflation is controlled.

In the case where the fed has to increase the money supply , it buys the securities from banks and open market and pays them money. This increases the reserves with the banks and increases the supply of money in the economy. This increase in supply of money reduces the interest rates in economy , makes borowing cheaper and expands the economy