Question

Book Principals of Finance question 17-3

Explain how the Federal Reserve manages to monetary policy of the United States. If the economy was in a recession characterized by high interest rates, what actions might the Fed take to exert downward pressure on those interest rates?

Answer 1

The Federal reserve exercises its monetary policy by various methods such as making changes in the interest rates, open market operations, regulation of foreign exchange rates and changing the required reserves of the banking system. The objectives of monetary policy are keeping inflation in control and regulating the growth and liquidity of the economy.

The Fed can regulate recession and high interest rates in the following manner:

1: directly lowering the interest rate will boost the economy because consumers and businesses will increase the amount borrowed by them. There will be additional investment in the economy which will help to bring the economy out of the recession.

2: open market operations namely buying U.S. treasuries will increase the amount of funds in the hands of people. This will increase the demand in the economy and hence spur investments.

3: reducing the required reserves of banks will also increase the money supply in the economy which will help to bring the economy out of recession.