Question

According to the IMF, the current Covid-19 lockdown globally has slid the world
economy into a global recession. As the Chairman of the Federal Reserve System, explain
the following.
a. What monetary policy should be taken (explain all the 3 tools) (70 words)
b. Show using the help of market of reserves (graphs), the impact of executing all the
3 tools in part (a)
c. Will all the tools (specified in part b) always work? With the help of graphs, specify
explaining details when it won’t.
d. Which tool are you most likely to use? Why?

Answer 1

a) The three monetary policy instruments are i) open market operation ii) discount rate iii) reserve requirement.

i) open market operation: in this policy, the government used to by or sell govt. bond to increase or decrease money supply in the market. it will shift the demand curve upward or downward.

ii) Discount rate: it is the interest rate charged by the central bank to the depositor institutions on the short term loan.

iii) Reserve requirements: it is the percentage of deposits that a bank used to keep with the central bank. so according to the requirement central bank use to increase or decrease the percentage of deposits.

b)

c) al these monetary policy tools are not effective all the time.it depends on the nature of the recession. if it is due to a shortage of money supply then the ii and iii will work whereas if the recession is through a sudden downfall the first one will work. so basically three major processes are there one is an increase in demand and another one is an increase in investment and the last one is tax reduction so all of these are specific to the situations.

d) very commonly use monetary tool is reserve requirement, in which the government can easily increase or decrease the requirement rate and there is not much difficulty to take this decision. this is less effort and more effective as the whole process is under control of central bank.