The monetary system in any economy facilitates trade and allows people to trade

Question

The monetary system in any economy facilitates trade and allows people to trade more efficiently, as compared to a barter economy. In the United States, the monetary authority is the Federal Reserve System (also referred to as the Federal Reserve, or informally, as the “Fed”.) For this assignment, use the information presented in the textbook and the Fed’s website (http://www.federalreserve.gov/) when addressing the questions below. 6. What are the tools available to the FED for controlling the money supply? Which are used most often? Which are most effective? 7. How does the money multiplier help to determine the effects of monetary policy? 8. What are the pros and cons of using monetary policy, as opposed to the use of fiscal policy, for implementing economic policies and practices?

Explanation / Answer

6. Tools of the FED for controlling the money supply are required reserve ratio, discount rate and open market operation.

Required reserve ratio is the percentage of deposits which banks have to keep with Fed. When FED increases this ratio then money supply will decrease in the economy and vice-versa.

Discount rate is the interest rate which FED charges from the banks for the loans they provide. When FEd increase interest rate then interest on public loan also increases and leads to reduction of money supply and vice-versa.

Open market operation is the sale and purchase of government securities by the FED. Sale of government securities sucks money from the economy while buying of securitities add more money and increase the money supply in the economy.

Open market operation is most oftenly used in the economy to control the money supply in an economy because of its efficiency.

7. Money supply depends upon the multiplier because multiplier shows the proportion of deposits which banks are required to hold as reserves. Increae in the value of multiplier means banks are able to increase more money and vice-versa.

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