Question

Which of the following monetary policy tools should not be used when the economy enters a recession, if the Fed wants to stimulate the economy?
                
Reduction in the fed funds rate
                
Reduction in the reserve requirements
                
Open market sales
                
Open market purchases

Answer 1

Open market sales

When an economy enters recession and Fed wants to stimulate the money then he should used expansionary monetary policy which will increase the money supply in the economy. Reduction in reserve requirement, reduction in fed fund rate and open market purchases are expansionary monetary policy and will increase the money supply in the economy because all these options will increase the lending capacity of the commercial banks because of increase in reserves of commercial banks. Whereas open market sales will decrease the money supply in the economy because sale of securities by central bank reduces the reserves of commercial banks. It adversely affect the bank's ability to create credit and therefore decrease the money supply in the economy. Therfore open market sales should not be used when economy enters recession and Fed wants to stimulate the economy as it decreases the money supply in the economy.