Question

Explain the 4 tools of monetary policy and how they impact interest rates, financial markets, housing, and GDP (20 points). Make sure to include the money graph.

I need the graph for Financial markets and Housing.

Answer 1

The objectives of monetary policy are controlling inflation; maintain unemployment, regulating currency exchange rates etc. The most important monetary policy tools are open market operations, reserve requirements and the discount rate. These three tools helped to maintain the sustain healthy economic growth. 1) Open market operations: Central banks buy or sell securities through OMO. When central bank purchases securities it will add to reserves of bank. When central bank sells securities it will reduce the cash holdings. Treasury bonds can influence the quantity of bank reserves and level of interest rate. This can reduce the quantity of money and loans in an economy. 2) Reserve requirements: Low reserve requirements allow banks to lend more. It is expansionary in nature because it creates credit. High reserve requirements lead low level lending by the banks. 3) Discount rate: Central bank charges a rate to borrow at its discount window. Banks used this tool if they can't borrow funds from other banks. A desperate bank that is been rejected by others would use the discount window. If central bank raises the discount rate the commercial banks reduce their borrowing reserves. 4) Interest on reserves: Newest and most frequently tool used in the monetary policy. This influence the bank lending. If there is lower interest rate it will pays on excess reserve S2 Interest rate SO EL S1 EO E2 D Output In the diagram, the expansionary monetary policy will shift the supply curve from SO to S1. The expansionary monetary policy through using the tools of lowering the reserve rates, interest rate and increasing discount rate. By contractionary monetary policy using increasing the reserve requirements and the lowering discount rate.