Answer and respond to the following: A. List four tools the Fed actually uses (m

Question

Answer and respond to the following:

A. List four tools the Fed actually uses (meaning has used within the last 15 years) to control the money supply. For each tool, do the following:

1. Define the tool.

2. Explain how the Fed would use that specific tool to increase the money supply.

B. You are a Research Associate for Janet Yellen, Chair of the Board of Governors of the Federal Reserve System. You believe the economy is entering an inflationary gap based upon recent data showing increases in consumer confidence and continuing increases in stock and housing prices. Use the scenario provided to do the following:

1.Beginning with the economy in an inflationary gap, use an aggregate demand and aggregate supply graph to explain how the Federal Reserve could get rid of the inflationary gap.

2. Provide a written explanation that describes the monetary policy tool the Fed is most likely to use to close the inflationary gap and how the Fed would use the tool to close the gap. You also need to explain how/why the Fed’s action affect the macro economy— in particular, the effects on the interest rate, consumer spending, investment spending, net exports, the price level, and aggregate income.

Explanation / Answer

OMO-Open-market operations consist of the buying and selling of government securities by the Fed. If the Fed buys back issued securities (such as Treasury bills) from large banks and securities dealers, it increases the money supply in the hands of the public.

2. Changing the Required Reserve Ration (RR)

Expansionary Monetary Policy: DECREASE RR
Contractionary Monetary Policy: INCREASE RR

3. Changing the Discount Rate (DR)

Expansionary Monetary Policy: DECREASE DR
Contractionary Monetary Policy: INCREASE DR

4. Term Auction Facility works like changing the Discount Rate

2. With the help of above tools fed can manipulate the demand and supply of money.

3.

The Fed can use the following tools to influence the money supply.

1. Open Market Operation: The Fed can affect the money supply by buying or selling U.S. government securities, using open market operations. When the Fed purchases a government security from the public, it does so with money that did not exist in the system. Thus, bank reserves will rise, increasing the money supply.

2. The Required-Reserve Ratio (r): The Fed can influence money supply by changing this ratio. This ratio specified the amount banks must hold as reserves on all deposits and limits the amount that banks may lend out. If the Fed increases the reserve ratio, the deposit and money multiplier will be smaller, thereby further limiting the amount by which banks may expand the money supply.

3.Discount Rate: Banks will borrow funds when needed. When the banks borrow from the Fed, they pay an interest rate called the Discount rate. When the discount rate is raised, banks will have less incentive to borrow, thus lowering the money supply in the system.

When the economy is in an inflationary gap, the Fed will adopt a contractionary monetary policy to decrease the money supply in the market by selling securities, raising the reserve rate, and/or increasing the discount rate. When the economy is in recessionary gap, the Fed will adopt expansionary monetary policy to increase money supply in the market by buying securities, lowering the reserve rate, and/or decreasing the discount rate

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