what are the main monetary tools the Fed uses? How does monetary policy affect key economic...

what are the main monetary tools the Fed uses? How does monetary policy affect key economic variables?

Expert Solution

Main monetary tools the FED uses:
1. Managing Interest rate : It has the power to increase or decrease interest rates and hence decreasing or increasing money supply to the economy.
2. Open Market Operation: By purchasing or selling securities in open market operation FED can opt for expansionary or contractionary monetary policy.
3. Reserve Requirement : By increasing the reserve requirements for the bank the FED can reduce money supply and by reducing reserve requirement for banks it can increase money supply.

The monetary policy by decreasing money supply can reduce inflation or vice versa. The reduction in money supply reduces demand for funds. It can stimulate growth and employment by increasing money supply. This can be achieved by purchasing securities in OMO , or reducing interest rates and lowering reserve requirements.

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