Question

Explain the three primary tools of the U.S. central bank (the Fed

Answer 1

The three primary tools of the Fed are:

Open market operations: Open market operations are the purchase and selling of the bonds in the market to banks and institutions. If the FEd is selling the bonds it will absorb the excess liquidity in the market and if they are buying the bonds form the market they will release the liquidity in the market.

Discount rate: Discount rate are the rates at which the FEd lend funds to the banks. IF they increase these rates the demand for the funds will decrease and the liquidity will be reduced and vice versa.

Reserve ratio: Another tool in the hand of the FED to manage the liquidity in the market are reserve ratio, it is basically the proportion of the deposits made in the banks which they have to keep with them. the higher the rates the lower the liquidity in the market and lower the rates the more the bank can lend to the market.