Question

2. Explain the following questions regarding monetary policy. 2.1.Discuss the three monetary policy tools of the Federal Reserve. 2.2.Explain how each monetary policy tool can be used to change the money supply and equilibrium interest rate in the U.S. 2.3.Using the IS-LM graph, what will happen to the equilibrium interest rate (i*) and equilibrium GDP (Y*) when the monetary policy action described in Question 2.2 is conducted. 2.4.Using the IS-LM model, explain in which situations such a monetary policy action is most effective. 2.5. What is the policy coordination? Using the IS-LM graph, explain why policy coordination is important.

Answer 1

Three monetory tools of the federal reserves are

The Discount rate

Reserve requirements

Open market operations

1. The discount rate is the interest rate charged by the Federal Reserve Bank on short-term loan deposits.Federal Reserve loans at discounted rates serve as a source of liquidity for commercial banks to meet federal fund rates targeting open market operations. Reducing the discount rate is extensive because the discount rate affects other interest rates.Low rates encourage consumers and businesses to borrow and spend. Similarly, increasing the discount rate is a contract because the discount rate affects other interest rates. Higher rates discourage consumers and business lending and spending. The Reserve Banks and the Board of Governors make changes to the discount rates.

2.Reserve requirements are parts of the deposit that banks must keep in their vaults or deposit with the Federal Reserve Bank. The reduction in reserve demand is widespread because it increases the funds available in the banking system for lending to consumers and businesses. The decrease in demand for reserves is generalized because it increases the money available in the banking system to lend to consumers and businesses. The increase in reserve requirements is limited because it reduces the money available in the banking system to lend to consumers and businesses.The Board of Governors has special powers over changes in booking requirements. Federal rarely changes reserve requirements.

3.Open market operation include buying and selling government securities. "Open market" means that the federal government does not decide on which day to deal with which stockbrokers. Instead, the choice is based on an "open market" in which various securities brokers, major brokers, who trade federally, compete on the basis of price.Open market operations are flexible and therefore the most widely used monetary policy tool.