Question

suppose on any given day there is an excess demand of reservers in the federal funds market. what would be the appropriate action for the fed to take keep the federal funds at its current level? would this action be an example of conventional or unconventional monetary policy, and would it be considered defensive or dynamic?

Answer 1

If there is excess demand for reserves in Federal Reserve, it will affect the natural interest rate. When the demand of reserves increased its lead to the fall down of money supply. With increasing rate of demand for the reserves the interest rate raises. The increasing rate of interest, the investment falls down. It reduces the overall production. The appropriate action take by Federal Reserve is expansion of monetary policy by increasing the money supply in the market. This is an example of conventional monetary policy. Conventional monetary policy is a set of tools of central bank to maintain the money supply level. The major conventional policy tools are open market operations, standing facilities, asset management etc. When the demand increased, the Federal Reserve’s increased the supply of money to the economy. Thus people can get more money to consume. The dynamics through increasing demand for reserves are increasing money demand of commercial banks by increasing the purchase of assets and the central bank provide the supply of money. This leads the decreasing interest rate, which raise the investment, production and the overall development of the economy.