Question

1. Why do people hold money? 2. What are the tools of monetary policy and how can the Federal Reserve apply these in a recessionary environment?

elaborate and the chapter is called the federal reserve system and monetary policy

Answer 1

1. People hold money to meet day to day expenses and for speculative purpose i.e. emergency needs.

2. Tools of monetary policy to control recessionary gap:

(i) Cash Reserve Ratio: CRR is the amount of deposits which each commercial bank is required to keep with Federal Reserve. Decrease in CRR increases amount of money available with banks and thus they are able to lend more which increases money supply and reduces recessionary gap.

(ii) Discount Rate: It is the interest rate charged by the Fed from commercial banks in return of loan provided. Decrease in discount rate increases borrowing of banks and thus banks lend more and able to increase money supply. This solves recessionary problem.

(iii) Open market operation: Open market operation is the sale and purchase of government securities in the open market by the Federal Reserve. By selling the securities, the central bank withdraws cash balances from the economy. And, by buying the securities, the central bank adds to cash balances in the economy. During inflation, central bank sells government securities and reduce the money supply and on the other hand, during deflation, central bank buy government securities. So, in case of recessionary gap, Fed buys government securities.