Question

Explain two ways the Federal Reserve could raise the Federal Funds Rate without changing the Money supply?

Answer 1

Ways in which Federal Fund can raise Fund rate are

1.Open market operations: involve the purchase and sale of government bonds from and to commercial banks and/or designated market makers. For example, when the central bank buys government bonds from commercial banks, this increases the reserves of private sector banks on the asset side of their balance sheets.If banks then use these surplus reserves by increasing lending to corporations and households thereby increasiing Federal Fund rate

2. Reserve Requirement: a central bank could restrict money creation by raising the reserve requirements of banks. However, this policy tool is not used much now a days in developed economies. For example, if a central bank increased the reserve requirements, a bank that was short on reserves might have to cease its lending activities until it had built up the necessary reserves thereby.