A. Describe three tools the Fed can use to raise interest rates. For each tool,

Question

A. Describe three tools the Fed can use to raise interest rates. For each tool, clearly state how it is used for this objective. 3-7 sentences.

B.Suppose that the reserve requirement ratio is 5% and that the Fed uses open market operations (OMO) by SELLING $60 million worth of Treasury securities. Assume that banks use all funds except required reserves to make loans and that the public does not store any cash. Given the information above, what is the best estimate of how much the money supply changes as a result of the Fed’s action? Be sure to state the direction (increase or decrease) as well as the amount. Show your work.

Explanation / Answer

Ans

A Fed can do it by increasing required reserve ratio. As a result banks can lend less. Thus interbank interest rate rise and banks raise there own interest rates Other tool is using open market operations to sell securities. As a result money supply decreases which raises interbank rate resulting inturn.in increase in bank lending rates. Lastly central bank can change discount rates at which they can lend to banks. As they raise it, interest rates rises.

2 Here money multiplier=1/5%=20

So maximum amount of increase in money supply=20(60)=1200 million

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