Question

Explain the tools available to the Federal Reserve to implement expansionary monetary policy and the tools available to the Federal Reserve to implement contractionary monetary policy.

Answer 1

Fed has three main monetary policy tools namely, open market operations, the discount rate, and the reserve requirement.

1. Open market operations- Open market operations are when fed buy or sell securities. These are bought from or sold to the country's private banks. A central bank buys securities when it wants expansionary monetary policy. It sells them when it executes contractionary monetary policy.

2. Discount rate- It's the rate that central banks charge its members to borrow at its discount window. If fed wants to increase money supply ,it decreases the discount rate . If fed wants to decrease money supply,it increases the discount rate.

3. Reserve requirements- 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.

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