Monetary Policy

Question 11

Tools of Federal Reserve Policy1

Open Market Operations1

Discount Rate1

Reserve Requirement2

Expansionary V/S Contractionary Monetary Policies2

Question 23

Question 34

References5

Question 1

Tools of Federal Reserve Policy

Three tools of Federal Reserve policy makers influence on money supply and interest rates:

Open Market Operations

This one is the most primary tool Federal Reserve is using is that buying and selling the US treasury securities. These buying and selling put impact over the extra reserves of the banks which are for the loan and creating money. This strategy is good for increasing the level of reserves of the banks. This increased level of the money supply makes the interest rates low. It is simply the law of demand and supply work in this matter. More reserves lower the interest rate on the other hand higher reserves decrease the money supple and increase the rate of interest (www.amosweb.com).

Discount Rate

Federal Reserve also adjusts the rate of interest which is being charged to the banks for the borrowing of reserves. High or low discount rates have an impact on the amount of surplus reserves which are available for making loans and creating money. When Federal Reserve Fed lowers discount rates, than banks have an opportunity of borrowing more reserves. Those reserves later can be use for making more loans at relatively lower interest rates. This lead towards an increasing trend of the money supply. If Federal Reserve increases the discount rate then banks will be able to borrow fewer reserves. Ones again fewer loans at higher interest rates will be the case, this will decrease the money supply. Change in the discount rate is the most commonly assumed indicator of action of monetary policy (www.amosweb.com).

Reserve Requirement

Federal Reserve adjusts the proportion of the reserves which all the banks should be keeping back outstanding deposits. Deposit multiplier can suffer due to the fluctuation in the rates. Deposit's amount banks create will also bear the influence. Lower reserve requirements by Federal Reserve can lead the banks in using the existing reserves for making more loans and this will cause an increase in the money supply. In case Federal Reserve increases reserve requirements then the banks can make use of the existing reserves for some more loans. This will also decrease the money supply in the economy (www.amosweb.com).

Expansionary V/S Contractionary Monetary Policies

These are basically policies performed by central banks. Expansionary policy is basically when Federal Reserve think about the expansion or increment of the money supply in an economy. In contrast to that, contractionary policy is when decrease in the money supply is the actual focus. Monetary policy tools are used by the Federal Reserve for maintaining the desired level of the money supply (financetrain.com).

Both the policies are used in accordance to the need of the economies. None if the two is actually good or bad. Both of them are auspicious only when they are deployed on correct timings. In case any of the two are not actually implemented when the economy has the demand. This procrastination can be ...