The federal reserve has three monetary policy tools: required reserve ration, th

Question

The federal reserve has three monetary policy tools: required reserve ration, the discount rate, and open-market operations. Briefly describe each of these tools and then comment on each tool's usefulness in controlling the money supply in the economy.

Step 1: review what the required reserve ration is and how it can affect the money supply. Why doesnt the Federal Reserve rely on this monetary polict tool to change the money supply?  15 points

Step 2: review what the discount rate is and how it can affect the money supply. Explain why the Federal reserve doe snot rely on this monetary policy tool to change the money supply. 15 points

Step 3: review what open market oprations are and how they can affect the money supply. Why does the Federal Reserve rely on this monetary policy tool to change the money supply. 20 points

Explanation / Answer

When the Federal Reserve System was established, its founders did not intend it to pursue an active monetary policy to stabilize the economy. The basic ideas of economic stabilization policy were foreign at the time, dating only from John Maynard Keynes' work in 1936. Instead, the founders viewed the Fed as a means of preventing the supplies of money and credit from drying up during economic contractions, as happened often in the pre-1914 period.

One of the principal ways in which the Fed was to provide such insurance against financial panics was to act as the "lender of last resort". That is, when risky business prospects made commercial banks hesitant to extend new loans, the Fed would step in by lending money to the banks, thus inducing banks to lend more money to their customers. (To learn more about the Fed, see The Federal Reserve.)

The function of the central bank has grown and today, the Fed primarily manages the growth of bank reserves and money supply in order to allow a stable expansion of the economy. To implement its primary task of controlling money supply, there are three main tools the Fed uses to change bank reserves:

A change in reserve requirements

A change in the discount rate

Open-market operations

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.