Question

800 words

1. Which of the monetary tools available to the Federal Reserve is most often used? Why?
2. Describe how expansionary activities conducted by the Federal Reserve impact credit availability, the money supply, interest rates, and security prices.
3. Suppose the Federal Reserve purchases $10 billion worth of foreign currency in exchange for deposit accounts at the Federal Reserve. Show the changes that result from this transaction on the Fed’s balance sheet.

Answer 1

The Federal Reserve’s three instruments of monetary policy are open market operations, the discount rate and reserve requirements.

Open market operations involve the buying and selling of government securities. The term “open market” means that the Fed doesn’t decide on its own which securities dealers it will do business with on a particular day. Rather, the choice emerges from an “open market” in which the various securities dealers that the Fed does business with – the primary dealers – compete on the basis of price. Open market operations are flexible, and thus, the most frequently used tool of monetary policy.

The discount rate is the interest rate charged by Federal Reserve Banks to depository institutions on short-term loans.

Reserve requirements are the portions of deposits that banks must maintain either in their vaults or on deposit at a Federal Reserve Bank